I am in my fifties and I have been saving and investing since I began working full time more than twenty-five years ago. I have been writing about my investing in these pages for about three years.
If you are in your 20s or 30s, perhaps you just started earning enough to save some, this post is for you. You have a long road ahead to invest and grow your savings. The key is to become familiar with the road ahead and the inevitable pitfalls you may face as you forge ahead as a saver.
Even if you are in your 40s, you still have twenty plus years of earnings to plan for. You too have time to become a successful investor.
What follows is my recommended investing approach for a young investor. I will highlight some key ideas and point to other blog posts for further reading.
Investing principles for a young investor:
- Start saving early:
The first step towards investing is saving any excess cash you may be earning today. Save as much as you can. Start saving early in your earning career.
Why start early? Because you want your money to grow and compound over a long time. The longer you can wait before you need to start spending from your savings, the higher your assets will grow. Compounding is exponential growth. See this: How does money compound over time?
Compounding works best if you reinvest all your profits. Do not be tempted to take money out early. In this post I show how withdrawing just 5% of savings every year would cut my gains by half by the time I am ready to retire: Reinvesting is key
I ran numbers on two hypothetical 25-year old savers. Both save an equal amount every year, but one keeps his savings in entirely cash (assume zero growth) and the other guy invests in an asset that grows and compounds 10% every year. After 25 years of saving this way, the guy who had invested in the growth asset took nearly unassailable lead over our cash-only saver. See this post for details: Seeking instant wealth? Don’t.
- Invest in growthy assets:
When we have a decade (or longer) to invest, we’d want to invest in an asset that grows quickly. From the previous discussion, clearly a slow-growth (or no-growth) safe asset like cash is not where we want to invest our long-term savings.
On the other hand, an asset promising very high return could also be bad. Why is that? Because any asset that promises to double your return in a short time period (say in a year or two) is probably an outright fraud. Or too risky. Risk and reward go hand in hand. The higher the promise of reward, the higher the risk of losing money.
Long-term investors don’t need to shoot for the stars. When we have time on our side, we don’t need to double our money every year – even a lowly rate (like 10% to 15% a year) is good enough for us. See this post: Don’t be dismissive of low returns
- Which assets to select:
Now that we know we need a reasonable-growth asset to invest in—something that is safe over the long-run but still able deliver high enough returns—we need to pick an asset type. My preferred asset type has always been publicly traded U.S. stocks. Stocks grow as the country’s economy grows. They will give us good growth over the long run and yet are safe too. I repeat, stocks are safe when we invest over five or ten years and longer.
What average return you could expect from the U.S. stock market? Over the previous 20 years, the market has returned 11% annual. When we invest in U.S. stocks for a period of ten years (and longer), there is almost no downside risk for us. See the chart in this post: Yes, stocks are volatile
Why I don’t consider gold to be a growth asset? Should you invest in gold?
Why I prefer investing in a business rather than owning a bond? When stocks turn into perpetual bonds?
Real estate can also be good growth asset to invest in. I invest in real estate too. Generally speaking, owning real estate directly can be more time-consuming than owning stocks. That’s why I own real estate through public securities (REITs), rather than directly. See this for details: How am I investing in commercial real estate?
If you are so inclined, investing in your own business could also become very profitable. But it is certainly riskier than stock investing. I never did though, as I preferred to work full-time for a salary and do armchair stock investing in my spare time.
If you chose to invest in stocks for growth, what would you buy? I recommend starting with a low-cost index fund (or a similar ETF) that broadly covers the U.S. stock market. When I had started investing some twenty-five years ago, nearly all my savings went into a couple of index funds that were available from my broker free of cost. See what index funds I hold in my portfolio today: A deeper look into my portfolio. Also read my 10-year investing journey with a Schwab index (see the link further down).
- Invest gradually and steadily:
If you are like me and have decided to invest in stocks, how’d you go about doing it? I’d say you do it gradually and steadily.
Gradually: There’s no need to rush into investing all your savings right way. If you have money parked in cash, spread out your stock purchases over 3 to 5 years. You’ll learn as you go. You have time on your side, so no need to rush into it.
If you are investing as you save every year, the best approach is to invest in installments. As you set aside money to save, you’d buy stocks with it. Perhaps, you buy once a month or once a quarter. Even once a year is fine too. See this: Investing in installments
Steadily: Keep a steady hand as you invest over the years. Do not second guess your investing approach as you encounter market fluctuations. Stay even keel. In this post I show how investors’ own bad behavior (like panic selling and market timing) hurt their returns: Most investors underperform the stock market
In the following post, I recounted how I invested steadily for 21 years in a retirement account, while the market went through two severe market declines. I still came out ahead: My 401(K) story—from 1992 to 2012
- Be prepared for volatility:
Mike Tyson once said that “everyone has a plan until they get punched in the mouth”. Investing in stocks also sounds easy, until the investor runs into a bear market. Many get scared out of investing then. The best way to avoid this fate is to prepare yourself ahead of time for inevitable market declines and panics.
The first thing to recognize is that your portfolio will go down in value sooner or later. If you will be investing over a period of ten years or longer, it’s almost a certainty that you will see major price declines. This is table stakes in this investing game.
It is good to know the market history and recognize this price volatility. On average stocks go down by 10% almost every year, 20% roughly every four years, and 30-40% every decade or so. Of course, it doesn’t follow a set pattern, but take it as a rough guide. I share more details of market declines here: Beware, the markets go down often.
I invested in a Schwab low-cost index fund for ten years starting in 1996. Then in the year 2000, we entered a long bear market. Stocks went down for three years in a row—from 2000 to 2002. That Schwab fund did not reach its previous high until the middle of 2006. And yet, over the same period, my portfolio generated 8.4% annual return. See this post: My ten-year odyssey with a Schwab index fund
You might be asking how long I would suffer through a market decline before things turn around. See this table on the S&P 500 decline history: Market history research.
In an average bear market, price decline goes on for about a year and a half followed by 25 months for full recovery. So a round trip usually lasts a bit more than three years. The key is to remember that stocks always recover eventually. No matter how bad the market declines gets to be. We just need to have faith.
- Have faith in the U.S. economy:
For successful long-term investing, we need to have faith in the economy. Here, I am talking specifically about the U.S. economy (it’s the one I am most familiar with) but this could also apply to other developed economies. The stock market’s success is tied to the country’s economy because stocks are fractional ownerships in real businesses. When the economy grows, the businesses earn more which in turn makes stocks more valuable.
U.S. economy is a steady growth engine. Most years it grows. Then occasionally it contracts (what economists call a recession), usually by about 1 to 3%. See how steady U.S. GDP growth has been over the last 70 years: Real investors don’t fear a recession
This steady economic expansion is interrupted occasionally by a contraction, See shaded regions in the GDP chart from previous link. This cycle of expansion-contraction is here to stay. But if you believe in the long-term upward trend of the U.S. economy (as I do) then you know that the U.S. stocks will also do fine. Though unlike the economy, stocks will be much more volatile. We just need to be patient when investing in them: Stock investing is not a zero-sum game.
- Ignore media, ignore experts:
You would do well as an investor if you are able to tune out the financial media and the so-called experts who appear there. The media is there to entertain you with today’s stories. Thinking five to ten years out is too boring and tedious. It’s not their job. They can’t be your financial advisers.
The way I see it, financial media brings out two kinds of bad behaviors in investors. One, because the media loves to predict what may happen to stocks in the following week, the month, or the year, it implicitly encourages investors to also think short term. It nudges us to get in and out of the market based on their predictions i.e. market timing.
Two, the media turns into dooms-day prophets when we are in stock market declines. Remember the saying: ‘if it bleeds, it leads’. Fear and panic keep viewers hooked. By piling on negativity over the pessimism already prevalent in a bear market, it makes inexperienced investors question their commitment to long-term investing.
Over the years, I’ve written several posts on media’s disservice to us, the long-term investors. Here’s a quick recap of some of those posts. If you are new to investing, I’d highly encourage you to go through the anecdotes I’ve shared in the below posts.
In the aftermath of the 2008-09 bear market, the financial press was expectedly in a dark mood. Even as late as 2012, full three years after the market had troughed, the media was still singing the blues. In the following post, I shared three anecdotes from that time period: A new book on financial planning recommending that people don’t invest any money in stocks, a journalist declaring that stocks are dangerous things to own, and a businessman spelling out his six reasons for not investing in the stock market at the time. It so happened that it was just about the best time to invest new money in stocks. Don’t take investing advice from people you don’t know.
Even when the market is doing well, the news media publishes sensational out-of-context, click-and-bait type stories such as this one from CNBC in July last year: “Danger is lurking in the stock market: A monster sell-off could be around the corner”: Gratuitous advice with no accountability
In the 2010-2012 period, the press was still lamenting the so-called lost decade of the stock market. As if the next decade would be equally bad. I showed in this post how a patient investor would have still made money in that decade-long flat market if he was dollar-cost averaging his savings all that time: Revisiting the lost decade of the stock market.