Imagine you’re a new investor in 1980.
If you wanted to put your money to work in the financial markets, you most likely had to drive to a brick-and-mortar office to meet with a broker. You would then have to fill out some paperwork to buy a severely limited number of tax-inefficient mutual funds or individual stocks. Those securities would often require an upfront fee in the 5% to 10% range for you to buy them. Next you would have to write a check to fund your account. The entire process could take days for all of the paperwork to go through. And once that account finally did get funded, if you wanted to make a change to your holdings, you had to get someone on the phone to do it for you. If you wanted to add money to your account, you had to fill out some more paperwork and write another check.
Now consider how new investors fund their accounts today.
You download an app to your phone, link your bank account by signing into the online portal, fund your account, and start making trades in a matter of minutes. Trading is free and allows you to use margin, buy and sell securities instantly, and trade options, ETFs, individual stocks, mutual funds, and crypto all with the click of a button. Future contributions and investment allocations can all be automated to occur at your convenience without lifting a finger. Changes to your portfolio can be made with a swipe of your phone. There is no need to deal with another human being in any of these transactions if you don’t want to.
The investment landscape has changed in a number of ways over the past four decades or so. Investors have more investment options; the barriers to entry for getting invested in the markets are basically nonexistent; fees have fallen off a cliff; there are more tax-efficient products and accounts than ever; and we can all use the handheld supercomputers we carry around in our pockets to manage our investments. There has never been a better time to be an individual investor.
But while lower fees and easier access to the markets are undoubtedly a wonderful leap forward for individual investors, there are some challenges that have arisen too.
Your investment choices are seemingly endless. You can now buy and sell stocks, bonds, options, ETFs, mutual funds, crypto, NFTs, artwork, wine, real estate, startups, fractional shares of cars, sneakers, and much more. It’s hard to know where to begin if you’re just getting started.
Plus, the fact that you can now trade with your smartphone makes it more tempting to constantly churn your account. Reams of academic research show the more you trade, the worse off your performance is.
As technology continues to improve, these challenges will only grow in scope and size.
So how should new investors think about keeping up in this ever-changing landscape?
Amazon’s Jeff Bezos once said he frequently gets asked the question, “What’s going to change in the next 10 years?” But he almost never gets asked, “What’s not going to change in the next 10 years?”
No one knows exactly what’s coming next for new investors. Trying to predict the future is often a fool’s errand. Using the Jeff Bezos framework of change, new investors have a higher probability for success in the markets focusing on what’s not going to change.
Here are some tenets of successful investing that won’t change in the years ahead:
Risk and reward are attached at the hip
If there’s one ironclad rule of investing in financial markets, it’s that earning returns above the rate of inflation requires you to accept risk in one form or another. There are no guarantees when it comes to what that rate of return will be, but you can’t expect to compound your money if you’re not willing to take some chances. This has never been more true than today with generationally low interest rates.
For young investors, this means face-ripping rallies in risk assets can sometimes turn into bone-crushing losses. You have to be willing to live through heavy losses in the short term to experience big gains in the long term. If you can’t live with some volatility, don’t expect your money to grow very much.
Markets are not always going to be easy
The U.S. Stock market bottomed from the pandemic-induced crash in late-March 2020. From that point on, the market basically moved in one direction—up. From the bottom on March 23, 2020, through the end of August 2021, the S&P 500 was up more than 100%. Many individual companies were up multiple times that.
You don’t have to be a genius to make money in such an environment, which is why it’s important to never confuse a bull market for intelligence. Pretty much anything you put your money into last year has experienced extraordinary gains for such a short period of time.
New investors need to understand it’s not always going to be this easy. Yes, the market tends to go up over the long run, but it can also be extremely challenging in the short run.
In fact, if we looked at every calendar year for the U.S. Stock market going back to 1928, it would show an average peak-to-trough drawdown in a given year of -16.5%. In more than three out of every five years there has been a double-digit pullback. One out of every four years has experienced a setback of 20% or worse.
Gains are always more fun, but you have to go into the stock market with the understanding it doesn’t always go in one direction.
Down markets are a good thing for young people
Risk can mean different things to different investors depending on where they are in their investor life cycle. If you’re retired and don’t bring in regular income anymore, a bear market becomes a scary proposition. You don’t have future savings to take advantage of down markets. You don’t have nearly as much time to wait out a potentially lengthy downturn. And you don’t want to put yourself in the position of selling your stocks when the market is down to fund your lifestyle. For these reasons, many retirees diversify their holdings more broadly to include safer asset classes like bonds and cash to see them through these periods of market turmoil.
Young people are at the opposite end of the risk spectrum. Young people regularly contributing money into the stock market should hope and pray for regular downturns. That’s how you buy in at lower valuations, higher dividend yields, and better price points. When you’re just starting out, your biggest assets are time and human capital (future earning power).
It’s never fun to live through a bear market when your money is in the market, but that’s the only way you can buy in at fire-sale prices. And if you’re a person just starting out in the markets in your twenties or thirties, you should expect to see multiple market crashes over the course of your lifetime.
Get used to it and be ready to buy when everyone else is running in the opposite direction.
Saving is your best investment
Coming up with trading strategies and following what’s going on in the markets will always be more exciting, but personal finance is going to have a much bigger impact for the majority of young people. It doesn’t matter how intelligent or skilled you are when it comes to the markets if you don’t save money on a regular basis.
You may have aspirations to be the next Cathie Wood, but even the most skilled investor in the world is useless if they don’t have any capital to deploy.
The best investment you can make from a young age is to put some time and effort into better understanding the importance of spending your money wisely, saving regularly, and allowing compound interest to do the heavy lifting for you over the long haul.
Certain of the securities mentioned in the article may be currently held, have been held, or may be held in the future in the author’s personal portfolio or a portfolio managed by Ritholtz Wealth Management.
This article is part of Coins2Day' s quarterly investment guide for Q4 2021.
