The party on the financial markets is long over. The chatter about hot stocks and fabulous opportunities in cryptocurrencies and NFTs has died down to a whisper. Recession and bear market are the big buzzwords these days.
This is clearly not the happiest time for investors. If you have never invested money in the market before, this may not seem like the most obvious time to start.
Still, there are advantages to investing in a bear market. As stocks fall in value and day traders quit, you’re less likely to get carried away by fads since almost none of them are profitable. Instead, you can concentrate on the main goal of increasing your wealth over the long term.
Most of my columns are aimed at people who are already involved in stock and bond investing and frequently use mutual funds or exchange-traded funds. But this column is a little different. It is written primarily for people who are still in school, or just starting out in the workforce, or are in the process of saving money for the future.
It’s for people like Lucy Neal, who graduated from North Central High School in Indianapolis this month and said in a note, “I feel like I have no idea what to do about my own financial.” to ensure security (even though I just graduated from my AP macroeconomics class!).
In a phone conversation, Ms. Neal said it would be helpful to have basic, trustworthy information on how to start and stay with investing. So here is a quick overview. It can be useful even if you’re an old hand at it, but it’s mainly intended for beginners. If you have other specific questions, please write to me and I will try to answer them.
The market decline this year shows how easy it is to lose money, even if you’re careful.
But investing can be rewarding if you start early, focus on the long term, and follow a few simple steps that I’ll explain.
Pay your bills first and save for emergencies before risking money.
Buy stocks — and if it’s right for you, bonds — with cheap, diversified index funds that track the entire market.
Think of investing as a marathon, not a sprint, with at least a 10-year horizon and preferably a much, much longer goal in mind.
Pay your bills first and save some
Investing involves risk taking. You can minimize these risks, but there is no way around it, especially if you invest money in the stock market.
So before taking any additional risks, please make sure you can pay your bills. After that, try to put enough cash aside for emergencies.
Spend a little less, save a little more, and do it regularly. You’ll soon have a nice nest egg. Keep it in a safe place.
The state of the stock market
The stock market crash this year was painful. And it remains difficult to predict what the future will bring.
A bank account or a money market fund makes sense for short-term savings, because your money is safe and you can access it quickly. You can find money market funds at big companies like Vanguard, Fidelity, T. Rowe Price or Schwab. Interest rates are low, but they are rising.
For longer-term secure savings, try I-Bonds issued by the Treasury Department that pay 9.62 percent interest (rate resets every six months), bank certificates of deposit, and high-yield savings accounts.
Buy stocks, not cryptocurrencies
Now you are ready to invest.
I only put my own money into broadly diversified funds that hold stocks and bonds, and I recommend that to anyone starting out. Stocks and bonds are the two most important asset classes, and you don’t need anything else. Funds — particularly index funds, which track the market — are a great, cheap way to buy stocks and bonds. (What do I mean by cheap? They tend to pay much lower fees than a so-called actively managed fund.)
Before proceeding, consider this: As an investor, I would not invest any money at all direct in cryptocurrency, NFTs, gold or wheat, other commodities or anything else. You don’t need them in an investment portfolio and you take an extra risk if you buy them.
If you invest in the overall stock market through index funds, you’re exposed to these things anyway because you own parts of the companies that engage, trade, or serve them. These include Coinbase, a platform that facilitates cryptocurrency trading, and PayPal, which owns Venmo and encourages customers to buy crypto. If these or other companies manage to make money from crypto, great; you will too. If they don’t, the losses will be offset by other stock investments.
That means diversification. Buy the entire market and you minimize the impact of a small portion of it, for better or for worse.
Now for stocks and bonds, if I had the great luxuries of youth and decades in advance to cover potential losses, I would focus on stocks. In fact, from what I know now, despite the pain of the bear market, I would be 100 percent invested in stocks if I were in my teens or 20s.
However, I don’t have that luxury. I’m closer to retirement than I was to my first job, so I own quite a few bonds, which are generally more stable than stocks and let me sleep at night. But bonds aren’t what I’d buy if I were 18 like Ms. Neal is because stocks are nearly twice as profitable as bonds over the long run: 12.3 percent annualized for stocks versus 6.3 percent for Bonds, based on Vanguard calculations of market returns from 1926 to 2021.
What about losses?
The bear market is on Ms. Neal’s radar. “I keep seeing the stock market at record lows,” she said in a phone call Tuesday. “But does that mean now is a good time to buy stocks?”
My answer was ambiguous.
Yes, it’s a great time to buy stocks if you really are into it for the long term. Prices are a lot better for buyers than they were at the start of the year because we are in a bear market, which simply means the stock market as a whole is down at least 20 percent from its peak. While the past does not guarantee the future, the fact is that the US stock market has consistently recovered from declines for at least 20 years. If you can plan to buy and hold stocks for 20 years or more, by all means buy now.
But no, it might not be a good time if you’re trying to make a quick buck. The development on the stock markets has been negative so far this year. You could lose money instantly. On the other hand, the market could start rising tomorrow and trend higher for a long time. I don’t think that will happen, but nobody really knows.
In short, understand the risks you are taking. Don’t buy stocks unless you’re willing to take a short-term “paper loss” and be able to keep your money in the market for a long time. And think about why you’re buying stocks in the first place.
stock index fund
Why is stock investing such an effective way to make money over the long term?
The answer may not be obvious. A number of “meme stocks” like GameStop and AMC rallied over the past year, not because they were solid investments, but mostly because a lot of people wanted them to move up and keep buying. For months, and sometimes even years, this type of herd behavior—what economist Robert J. Shiller calls “irrational exuberance”—can drive up prices and net you handsome profits.
But if you rely on strangers’ emotions to set prices for you, you can also lose a lot of money when the market falls, as it has been doing lately.
Ms. Neal, an economics student, has found what I think is a good answer: stocks bring long-term returns to shareholders because the economy is growing over the long term and companies collectively benefit in the stock market. These growing profits benefit shareholders. And that’s essentially what you are as a stock investor — a shareholder — even if you own just a tiny part of a company through an index fund.
This growth has been exceptional for very long periods of time. The 12.3 percent annualized return on the stock market means your money would have doubled over many decades, on average, in less than six years.
Note that we’re not talking about picking specific stocks. Which companies will succeed and which will fail? Which stocks will do better this year or next? It’s hard to know.
Likewise, no one knows where the stock market is going from day to day or year to year. In December, the vast majority of Wall Street forecasters said the stock market would rise in 2022. Oops. You got it wrong.
None of this matters if you invest in the entire market for the long term and invest money regardless of short-term movements in the market. This approach is incredibly simple. You can use just one index fund to cover the entire US. Stock market or even the stock market of the whole world. Look for an index fund with low fees by comparing what’s known as an expense ratio. Look around, do your research.
Keep your investing as simple and as cheap as possible. As John C. Bogle, founder of Vanguard and creator of the first commercially available index fund, put it, “When you invest, you get what you don’t pay for.”
Don’t put yourself in a situation where short-term declines or falls in individual stock prices can really hurt you. Set yourself up with solid, diversified, low-cost index funds instead, and you’ll be in a great position to take advantage of the economy’s growth over the long term.