The party in the financial markets is long over. Chatter about hot stocks and fabulous opportunities in cryptocurrencies and NFTs has died down to a whisper. Recession and bear market are the big buzz words these days.
Clearly, this is not the happiest of times for investors. If you have never put money into the market before, this may not seem the most obvious time to start.
Yet there are advantages to investing in a bear market. With stocks falling in value and day traders giving up, you are less likely to be swept away by fads because almost none of them are profitable. Instead, you can focus on the essential goal of increasing your wealth over the long run.
Most of my columns are aimed at people who already have some involvement with stock and bond investing, often using mutual funds or exchange-traded funds. But this column is a little different. It’s written mainly for people who are still in school, or just starting in the work force, or just getting around to salting away money for the future.
It’s for people like Lucy Neal, who graduated this month from North Central High School in Indianapolis, and said in a note, “I feel like I have no idea what to do to ensure my own financial safety (even though I’ve just completed my AP Macroeconomics class!).”
In a phone conversation, Ms. Neal said it would be helpful to have basic, trustworthy information about how to start investing and stick with it. So here’s a quick rundown. It may be useful even if you are an old hand at this, but it is intended mainly for beginners. If you have other, specific questions, please write in and I’ll try to answer them.
The market decline this year shows how easy it is to lose money, even if you are careful.
Yet investing can be rewarding, if you start early, focus on the long run and follow some simple steps, which I’ll explain.
Pay your bills first, and save for emergencies, before putting any money at risk.
Buy stocks — and, when it’s right for you, bonds — using cheap, diversified index funds that track the entire market.
Think of investing as a marathon, not a sprint, with a 10-year horizon at a minimum and, preferably, with a much, much longer goal in mind.
First, pay your bills, and set aside some savings
Investing involves risk-taking. You can minimize those risks, but there is no getting around them entirely, especially when you put money into the stock market.
So before taking any additional risks, please make sure you can pay your bills. After that, try to salt away enough cash for an emergency.
Spend a little less, save a little more and do it regularly. Soon, you will have a nice nest egg. Keep it in a safe place.
The State of the Stock Market
The stock market’s decline this year has been painful. And it remains difficult to predict what is in store for the future.
For short-term savings, a bank account or money market fund makes sense because your money will be secure and you can get hold of it quickly. You can find money market funds at major companies like Vanguard, Fidelity, T. Rowe Price or Schwab. The interest rate is low, but it is rising.
For longer-term secure savings, try I bonds, which are issued by the Treasury Department and are paying 9.62 percent interest (the rate is reset every six months), bank certificates of deposit and high-yield savings accounts.
Buy stock, not crypto
Now you’re ready to invest.
I put my own investment dollars only into broadly diversified funds that hold stocks and bonds, and that is what I recommend for anyone starting out. Stocks and bonds are the two main asset classes, and you don’t need anything else. Funds — specifically, index funds that track the market — are a great, cheap way to buy stocks and bonds. (What do I mean by cheap? You will generally pay much lower fees than in what is known as an actively managed fund.)
Before going any further, consider this: As an investor, I would put no money at all directly into cryptocurrency, NFTs, gold or wheat, other commodities or anything else. You don’t need them in an investment portfolio and will be taking on extra risk if you buy them.
What’s more, if you invest in the entire stock market through index funds, you will be exposed to these things anyway because you will own pieces of the companies that engage, trade or service them. That includes Coinbase, a platform that enables trade in cryptocurrencies, and PayPal, which owns Venmo and encourages customers to buy crypto. If these or other companies manage to make money through crypto, great; you will, too. If they don’t, the losses will be offset by other stock investments.
That’s what diversification means. Buy the whole market and you minimize the effect, for better or worse, of any small part of it.
Now, for stocks and bonds: If I had the great luxury of youth, with decades ahead to recoup possible losses, I would focus on stocks. In fact, despite the pain of the bear market, understanding what I know now, I would invest 100 percent in stocks if I were in my teens or 20s.
I don’t have that luxury, though. I’m closer to retirement than to my first job, so I own a fair amount of bonds, which are generally more stable than stocks and let me sleep at night. But bonds are not what I would buy if I were 18 years old, as Ms. Neal is, because stocks return almost double what bonds do over the long run: 12.3 percent, annualized, for stocks versus 6.3 percent for bonds, according to calculations by Vanguard of market returns from 1926 to 2021.
What about losses?
The bear market is on Ms. Neal’s radar. “I keep seeing that the stock market is at record lows,” she said in a phone conversation on Tuesday. “But does that mean it’s a good time to buy stocks?”
My answer was equivocal.
Yes, it is a great time to be buying stocks if you are truly in it for the long run. Prices are much better for buyers than they were at the beginning of the year because we are in a bear market, which means simply that the stock market over all has fallen at least 20 percent from its peak. While the past doesn’t guarantee anything about the future, the fact is that the American stock market has always recovered from declines over stretches of at least 20 years. If you can plan on buying and holding stocks for 20 years or more, by all means, buy now.
But no, it may not be a good time if you are trying to make money quickly. The trend in the stock market so far this year has been negative. You could immediately lose money. Then again, the market could start rising tomorrow and keep trending upward for a long while. I don’t think that’s about to happen, but no one really knows.
In short, understand the risks you are taking. Don’t buy stocks unless you are prepared to endure “paper losses” over the short term and can keep your money in the market for a long time. And consider why you are buying stocks in the first place.
Stock index funds
Why is stock investing such an effective way to make money over the long term?
The answer may not be obvious. A bunch of “meme stocks” like GameStop and AMC rose sharply last year, not because they were solid investments but mainly because a lot of people wanted them to rise and kept buying. Over months and sometimes even years, this kind of herd behavior — what the economist Robert J. Shiller calls “irrational exuberance” — can inflate prices and give you a handsome profit.
But if you rely on the emotions of strangers 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, came up with what I think is a good answer: Stocks provide long-term returns to shareholders because the economy grows over the long run, and the companies in the stock market, taken together, profit. Those growing profits accrue to shareholders. And that’s what you essentially are as a stock investor — a shareholder — even if you own only a tiny slice of a company through an index fund.
Over very long periods, that growth has been extraordinary. The 12.3 percent annualized return from the stock market means that, on average, your money would have doubled in less than six years, again and again, over many decades.
Notice that we’re not talking about picking any particular stocks. Which companies will thrive and which will fail? Which stocks will perform better this year or next? It is hard to know.
Similarly, 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. Whoops. They got it wrong.
None of that is critical if you invest in the whole market for the long haul, putting money in regardless of the market’s short-term movements. This approach is incredibly simple. You can use just one index fund to capture the entire U.S. stock market, or even the entire world’s stock market. Look for an index fund with low fees by comparing what’s called the expense ratio. Shop around, do your research.
Keep your investing as simple and as cheap as possible. As John C. Bogle, the founder of Vanguard and creator of the first commercially available index fund put it, “In investing you get what you don’t pay for.”
Don’t put yourself in a spot where short-term declines in the market or in the fortunes of individual stocks can really hurt you. Instead, set yourself up with solid, diversified, inexpensive index funds and you will be in a great position to prosper from the growth of the economy over the long run.