Is Now A Good Time To Invest In The Stock Market?
A Beginner’s Guide On Where To Put Your Money
Welcome to Taking Stock, a space where we can take a deep breath and try to figure out what the COVID-19 economy really means for our finances. Every month, personal finance expert Paco de Leon will answer your most difficult, emotionally charged questions about money. This year has forced many of us to reprioritize our finances, and there’s no clear road map for getting through the pandemic yet — but Taking Stock is here to help us figure it out together.
This week, we’re talking about how to start investing in the stock market as a complete beginner, when it all seems so daunting and inscrutable.
I'm the Jon Snow of stocks: I know nothing. I have absolute zero involvement in stocks, not even a 401K, and even though I'm an adult who can pay their bills and figure out a budget, the idea of dipping my toes into investments has always been extremely intimidating.
But in the past year I've read a lot about people buying and selling stocks and making money from it. If I had bought a lot of Zoom stock before March 2020, I guess I might be feeling pretty happy now? All of these stories on how other people have won big while playing the stock market during quarantine has brought out my curiosity. I don't have a lot of savings right now, but is there a smart and safe way to start dabbling? What are the different ways you can get involved, and how much money would I need to start off with? What are the biggest mistakes a newbie like me could make?
Disclaimer: I realize this is a financial advice column… but this is not investment advice.
Dear Jon Snow of Stocks,
I can’t tell if the stock market is actually an exciting place right now or if it’s only exciting because, well, we’re 11 months into this pandemic and we have to find our thrills where we can.
I didn’t always think investing was boring. Before I got a finance degree, I had the same curiosity you have right now. I had a vague notion of investing: people put money in the stock market, sat back, did nothing, and watched that money turn into more money. From where I sat, and maybe from where you’re sitting now, investing seemed like black magic surrounded by an intimidating aura. But investing is just like baking bread, or rollerblading: It’s only intimidating when you don’t understand the fundamentals.
So, let’s unpack the fundamentals. Even if you want to try your hand at short-term investing, knowing the fundamentals, the risks, and thinking about the long-term are essential.
Taking prudent risks
When you invest money, you take the risk of losing all of it. This is the basic contract you are entering into when you invest. You’re taking risks with money you don’t need right now, in the hopes that the risk pays off in the future.
But there are things we can do to minimize risk, like applying the following fundamental principles to our investment strategy.
First, build a secure, solid foundation
You mentioned that you don’t have much money saved. Since investing is inherently risky, let’s not take a chance with money you might need in the short term. Before you dive into investing, build a solid and secure financial foundation with an emergency fund. If you’re still working on building your emergency fund, focus the majority of your monthly savings (if not all of it) on building that up. When your emergency fund is complete, redirect that same amount into investments.
Retirement accounts are the gateway drug to investing
Investing through your employer-sponsored retirement plan is the easiest way to get started. When you do this, you invest a portion of every paycheck, no matter what the market is doing. This technique is called “dollar-cost averaging.” It’s a very boring strategy where you buy stock shares at various price points, instead of in one lump sum, eliminating the need to try to “time the market.” By buying into the market over time, you’re basically spreading out the risk.
Some employers sponsor a 401(k) or another retirement plan like a SIMPLE (Savings Incentive Match Plan for Employees) IRA, and schools or non-profits might offer a 403(b) plan. An HR rep at work can let you know what, if any, retirement plans your company sponsors, and how to start contributing to it.
If your employer doesn’t offer a retirement plan, you’re likely eligible to set up an individual retirement account (IRA). If you’re self-employed, you can also contribute to an IRA, but there may be other options that are a better fit depending on your tax situation. Your small business accountant would be a great resource for guidance in this case.
Different retirement accounts and employer-sponsored plans have different rules. Each account has a contribution limit for how much you can invest in one year. Different plans will also have varying rules about whether or not you can borrow money from your retirement account for something like a down payment on your first home.
I started my first IRA with $25 and I invested $25 every subsequent paycheck. It felt completely pointless at first, but eventually, I was able to increase my contributions and the balance grew, which encouraged me to continue investing. In retrospect, setting up the plan and simply starting the behavior was a big step. You don’t need a minimum amount to get started with most retirement accounts.
Investing for most is putting money into a fund, not buying individual stocks
An investment fund is a basket of investments that holds stocks, bonds, and sometimes other funds, among other things. A fund allows investors like you, me, and a bunch of strangers to pool our money together, which gives us access to a wider variety of investments. It’s a way to diversify the stocks we’re invested in so it’s a lot less risky for all of us. And by buying into funds, we’re outsourcing most of the work of choosing what to buy.
For example, the S&P 500 is an index of the 500 largest U.S. companies; it’s viewed as a measurement of how well the stock market is performing overall. You can buy an exchange-traded fund (ETF) that holds investments exactly the way the index does. So if you buy shares of the S&P 500 ETF, you’re technically invested in 500 companies in the exact proportion of the index. If you had to find 500 viable companies to invest in on your own time, it would be a full-time job — and tracking it sounds like my own personal hell.
The big winners you’re seeing and hearing about right now were most likely buying and selling individual stocks, or buying riskier investment vehicles like futures, which is an entirely different ball of wax. The point is, they made their gains because their gains were the exception, not the rule. What they’re doing is called “stock picking” or “day trading” — it’s not how most investors invest, as much as the media might lead you to believe it is. Stock picking is risky because you put all your eggs in one basket, and you try to pick the perfect time to buy and sell a stock in order to make a profit. For all the success stories, there are many tragic stories.
The downside to putting all your eggs in one basket is that if there’s a sudden scandal involving the CEO of the company you bought stock in, a great economic shock, or your timing for selling is off, you will lose a lot — or all — of your eggs.
This isn’t to say that you should never buy individual stocks. But in terms of risk, it behooves you to make sure holding individual stocks is part of a larger investment strategy. Generally, that means a couple of things. First, have the majority of your investments in diversified funds that spread risk out. Second, only invest a smaller portion in higher-risk investments, like individual stocks. For example, if you have $10,000 in diversified funds, allocating no more than $200 to buy and sell individual stocks is a way to responsibly take some risk. The majority of investors are invested in fully-diversified funds and leave individual stocks up to professional traders, speculators, and anybody else who has the tolerance for risk and market volatility.
Investing and time: When do you need the money?
In the same way that you can have multiple savings accounts for multiple things, you can have multiple investment accounts. What dictates the type of account you open and what you invest in is based on when you need the money.
If you’re 21 and investing in a retirement account that you don’t need to access for at least 40 years, you can take more risk now because you have time to ride the ups and downs. But if you’re investing money for a down payment for a home that you plan on purchasing in the next 10 years, you probably won’t take on as much risk. If you need the money in your checking account for rent next month, you won’t invest it at all because you can’t afford to lose it.
In general, the more time you have to invest, the more risk you can handle. We all have a general idea of when retirement is, and the amount of risk you should take is dictated by that target date. This is another reason why retirement investing is one of the easier investment plans to begin with.
Technology has made investing accessible and easy
When I first started working in finance, investment clients had to complete and sign a 15-page paper application. They also had to have a minimum of $1 million to work with us.
Today, technology has eliminated a lot of inconveniences and barriers. You can download an app and have a human deliver an avocado to your front door within the hour. And you can invest without having a million dollars or physically signing a 15-page paper application. Fintech is revolutionizing how we manage, invest, and spend our money.
Zero-minimum platforms exist now, and you can still get investment advice from a real-life human advisor or a robo-advisor through these online platforms. I personally like and recommend Fidelity and Betterment to friends and readers, but I always include two pieces of advice: One, spend a little time to learn the fundamentals. Two, make a plan that drives your decisions — so your emotions don’t.
Spend an afternoon learning the fundamentals of investing
You can learn the broad strokes of investing in a half a day. My preferred method of learning is through reading books. I like books because I know the author has spent a considerable amount of time working on educating the reader; several editors have had to read the book, and it’s been fact checked. This doesn’t always happen with content you read online, especially on social media. Two great books specifically about investing that are easy reads are Broke Millennial Takes On Investing: A Beginner's Guide to Leveling Up Your Money by Erin Lowry and Money: Master the Game: 7 Simple Steps to Financial Freedom by Tony Robbins.
Mind your emotions
Currently, we’re experiencing a moment of market mania. For a lot of reasons, there’s a lot of money flowing into the market. As you know, demand pushes up the price of everything. Even so, I don’t think this should deter long-term investors from investing. The same thing is true during a market downturn. Falling prices shouldn’t deter long-term investors from investing. When you invest in a consistently boring fashion over the long term, historical data tells us that you’ll likely end up with more money than you started with. It may be modest compared to Zoom stock windfalls when the pandemic first began, but it also doesn’t require you to take on huge risk, to be struck with dumb luck, or to do a part-time job’s worth of work into researching investments.
I hope this helps you feel a little less intimidated — and helps you get started on the road to long-term investing!
Your finance friend,
Are you invested in the stock market? Do you do safer long-term investments through retirement plans and funds, more risky day trading, or a mix of both? How did you get started? What mistakes would you advise newcomers to avoid? What misconception do you think people have about the stock market? Share your experience here.
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