How to start investing in a bear market
The party in the financial markets is long over. Talk of hot stocks and fabulous opportunities in cryptocurrencies and NFTs has dwindled to a whisper. Recession and bear market are the big buzzwords these days.
Obviously, this is not the happiest time for investors. If you’ve never put money in the market before, now may not seem like the most obvious time to start.
Still, there are benefits 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 as almost none of them are profitable. Instead, you can focus on the essential 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, often using mutual funds or exchange-traded funds. But this column is a little different. It’s written primarily for people who are still in school, or just getting started in the workforce, or just starting to spend money on the future.
It’s for the likes of Lucy Neal, who graduated this month from North Central High School in Indianapolis, and said in a note, “I feel like I don’t know what to do to ensure my own financial security (even though I just finished my AP macroeconomics course!).”
In a phone conversation, Ms Neal said it would be helpful to have reliable basic information on how to start investing and how to stick with it. So here is a little overview. It can be useful even if you’re a regular, but it’s mainly for beginners. If you have any other specific questions, write to me and I will try to answer them.
This year’s market decline shows how easy it is to lose money, even if you’re careful.
Still, investing can be rewarding if you start early, focus on the long term, and follow a few simple steps, which I’ll walk you through.
Pay your bills first and save for emergencies before you put money at risk.
Buy stocks – and, if that suits you, bonds – using inexpensive, diversified index funds that track the broader market.
Think of investing like a marathon, not a sprint, with a minimum 10-year horizon and preferably with a much, much longer goal in mind.
First, pay your bills and set aside savings
Investing involves taking risk. You can minimize these risks, but it’s impossible to avoid them entirely, especially when investing money in the stock market.
So, before taking any additional risks, make sure you can pay your bills. After that, try to collect enough money 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 decline in the stock market this year has been painful. And it remains difficult to predict what awaits us for the future.
For short-term savings, a bank account or money market fund makes sense because your money will be safe and you can get it back quickly. You can find money market funds at big 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 pay 9.62% interest (the rate resets every six months), bank certificates of deposit, and bank accounts. high-yield savings.
Buy stocks, not cryptos
You are now ready to invest.
I place my own investment dollars only in broadly diversified funds that hold stocks and bonds, and that’s what I recommend to anyone just starting out. Stocks and bonds are the two main asset classes, and you don’t need anything else. Funds – especially index funds that track the market – are a great inexpensive way to buy stocks and bonds. (What do I mean by cheap? You’ll usually pay much lower fees than in what’s called an actively managed fund.)
Before you go any further, consider this: as an investor, I wouldn’t put any money at all directly in cryptocurrency, NFT, gold or wheat, other commodities or anything else. You don’t need them in an investment portfolio and you’ll be taking on additional risk if you buy them.
Also, if you invest in the broader stock market through index funds, you will be exposed to these things anyway because you will own shares of the companies that hire, market or service them. This includes Coinbase, a platform that enables 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 too. If they don’t, the losses will be offset by further equity investments.
This is 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 luxury of youth, with decades ahead of me to recoup any losses, I would focus on stocks. In fact, despite the pain of the bear market, understanding what I know now, I would 100% invest in stocks if I was a teenager or in my twenties.
I don’t have that luxury, though. I’m closer to retirement than my first job, so I own quite a few bonds, which are generally more stable than stocks and allow me to sleep at night. But bonds aren’t what I’d buy if I were 18, as Ms. Neal is, because stocks are paying almost double what bonds do over the long term: 12.3%, annualized, for equities versus 6.3% for bonds, according to the calculations. by Vanguard of market returns from 1926 to 2021.
What about losses?
The bear market is on Ms. Neal’s radar. “I continue to see the stock market is at record highs,” 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, now is a great time to buy stocks if you’re really into it for the long haul. Prices are much better for buyers than they were at the start of the year because we’re in a bear market, which just means the stock market as a whole is down at least 20% from relative to its peak. While the past does not guarantee anything for the future, the fact is that the US stock market has always recovered from declines over periods of at least 20 years. If you can plan to buy and hold stocks for 20 years or more, buy now.
But no, now might not be the right time if you’re trying to make a quick buck. The stock market trend so far this year has been negative. You could immediately lose money. Again, the market could start rising tomorrow and continue to rise for a long time. I don’t think that’s happening, but no one really knows.
In short, understand the risks you are taking. Don’t buy stocks unless you’re prepared to take short-term “paper losses” and can keep your money in the market for a long time. And consider why you are buying stocks in the first place.
Equity index funds
Why is investing in stocks such an effective way to make money in the long term?
The answer may not be obvious. A bunch of ‘meme stocks’ like GameStop and AMC rose sharply in the last year, not because they were solid investments, but mainly because a lot of people wanted them to rise and continued to to buy. Over months and sometimes even years, this kind of herd behavior — what economist Robert J. Shiller calls “irrational exuberance” — can inflate prices and net 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 drops, as has been the case lately.
Ms. Neal, an economics student, offered what I think is a good answer: stocks provide long-term returns to shareholders because the economy grows over the long term and publicly traded companies, taken together, make benefits. These growing profits accrue to shareholders. And that’s essentially what you are as an equity investor – a shareholder – even if you only own a tiny part of a company through an index fund.
Over very long periods, this growth has been extraordinary. The stock market’s 12.3% annualized return means that, on average, your money would have doubled in less than six years, over and over, over several decades.
Note that we are not talking about choosing specific actions. Which businesses will thrive and which will fail? Which stocks will perform best 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. Whoops. They were wrong.
None of this is essential if you are investing in the broad market for the long term, investing money regardless of short-term market movements. This approach is incredibly simple. You can use a single index fund to capture the entire US stock market, or even the global stock market. Look for a low fee index fund by comparing what is called the expense ratio. Shop around, do your research.
Keep your investment as simple and as cheap as possible. As John C. Bogle, the founder of Vanguard and creator of the first commercially available index fund, said, “In investing, you get what you don’t pay for.”
Don’t put yourself in a position where short-term declines in the market or the fortunes of individual stocks can really hurt you. Instead, settle in with strong, diverse, inexpensive index funds and you’ll be in a great position to take advantage of long-term economic growth.