As someone who invests more than half its income, I know how stressful it can be to invest in a falling market. It is hard to know how to invest in a bear market and keep your cool. When the markets are falling it is counter-intuitive but the best thing to do might just be to invest more and ride the fall.
We see it times after times when the markets tank. The media starts yelling on every rooftop: SELL sell sell! This is the classic buy high, sell low, method everyone is talking about right? In his 1997 letter to shareholders, Warren Buffett wrote:
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If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. […] This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices. – Warren Buffett
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Over and over again, the market had its ups and downs but high savers with long-term investment goals should be happy about those bargain prices. Staying on the sidelines will not make you rich. To benefits from the great wealth-producing powers of the market, you can invest in a low-cost, highly diversified, index funds and try to automate all your savings.
The now infamous 1982 Business Week cover: “The Death of Equities”. As it turned out marked the beginning of the greatest bull market of all times just goes to show you how the media should not always be followed.
If you look at any bear market, even the Crash of 1987, biggest one-day drop in history (brokers were, literally, on the window ledges and more than a couple took the leap), the market always recovers.
Always.
If someday it really does not, well, no investment will be safe and money will probably have no value anyway.
All-in-all, you cannot time the market and even market valuations will misguide you. Some easy steps to wealth are to you automate your savings, cut your spending, invest, and forget about it. Time will show again and again that equities will be volatile (it might be scary at times). How on the longer term, equities will always trump over cash. Staying on the sidelines is never a long-term solution.
Start investing today
Today is a better day to invest than yesterday. The longer your time horizon, the better chances are of positive returns. For example, over any 1-year holding periods, the worst yearly average return was -37% and the best was +52.62%. However, this changes drastically over longer periods.
Over 15-year periods, the worst average return was of +4.31% and the best of +18.93% per year. Finally, over any 25-year periods, the worst average yearly return was of +7.94% and the best was +17.24%.
If you are a millennial like me and have a few decades to invest, we can assume the average of the last century to hold true and generate considerable wealth over our lifetime. The annualized stock market return for the overall period is about 11% or about 7% after the average inflation rate.
The best day to start investing is today.
Do not try to time the market and do not try to outsmart the market. My best advice for you is to invest in a simple, low-cost, index fund and hold it long term.
The thing is, if you wait for the perfect entry point, you might just miss a great run up and miss on huge profits. On the other hand, if you invest now, even if the market could crash tomorrow you would not even feel the crash over the long-run.
If you want more details you can read my post on why you should invest in index funds.
Time is on your side
As a millennial, I will be over 50 years in the markets over my lifetime. Even more, if I choose to pass it on to my estate. My biggest asset is Time! I have recently read a great book by Patrick O’Shaughnessy. He is a portfolio manager at O’Shaughnessy Asset Management, who wrote about how millennials can get over their fear and into the market. It is worth the read, you can get Millennial Money: How Young Investors Can Build a Fortune at your local library for free.
This book introduces a strategy that can help overcome our shortcomings as investors. It underlines the fact that we have time on our side. You simply cannot underestimate the power of compounding!
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Make it all automatic and check your accounts as infrequently as possible. – Patrick O’Shaughnessy
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With that much time ahead of you, savings become much more rewarding. For example, if you would invest only 2,300$ per year for 50 years, (I hope you are saving way more if you are reading this blog!) you would reach the 1,000,000$ with average returns after inflation of the S&P500.
Source: Moneychimp Calculator
Automate your savings
The fallacy in humans is that we tend to overreact and get emotional when investing. The majority of investors know the secret of making money: Buy low, Sell high. However, our instincts actually make us buy high and sell when the markets are low.
Just look at the financial headlines or popular financial shows like Mad Money with Jim Cramer. Every time a stock rise and rise he will say that it is a HOT pick and time to get in the action! When it slumps he starts shouting at you to sell.
The easiest way I found to ignore the noise and invest logically is to automate my savings.
- Check with your employer for a 401k match and start investing on every paycheck. (or RSP in Canada)
- Check for employee ownership plans, most of them will match and there again, make it automatic on every pay.
- Set up an automatic transfer from your bank account to your brokerage account, either every year, month, pay or week. Then, set that amount to be invested in your desired allocation automatically.
Want something completely automated? We suggest Wealthsimple.
Start your automatic investment account today!
If you are hesitating between investing every paycheck or just investing in a lump sum, you can read my thoughts on the best way to invest and lump sum investing. I personally invest every pay just for simplicity. I do not think about it and never need to look at it.
Many brokers such as Vanguard offer free ETF trades. You can also choose a low-cost index mutual funds if your broker does not offer free trades. In Canada, we have the TD e-series mutual funds that are really cheap or you can set up accounts with Questrade who offers free ETF purchases. If you are interested in exactly what I invest in, you can read my Open Book series to see my holdings.
You should also check out with your employer for a 401k match and employee ownership plans that might be offered to you. Not maxing out these accounts is like leaving free money on the table.
Cut your spending
Cutting your spending is a double edge sword. It will not only slash your retirement nest requirement but also increase your savings rate. The size of your required retirement nest is a direct result of your spending. The more you get used to a certain level of spending, the more you will need before you can safely retire.
Using the general rule of thumb of 4% safe withdrawal rate from the Trinity Study, your nest requirement would be about 25 times your yearly spending.
If you are spending 40,000$ a year you will need 40,000 x 25 = 1,000,000$ in retirement nest. You will then be able to live off that amount. Withdrawing 40k plus inflation every single year would have a very high chance of success. Some prefer to be safer and use a 3% withdrawal rate, therefore, 33x your annual spending.
Cutting your spending will directly affect this total goal for financial freedom. Therefore, the number of years you will need to work. The more you can put aside in your accumulation phase, the sooner you will be able to retire. The basic principles behind early retirement are fairly simple; if you can save more than 65% of your income, you can attain financial independence in less than 10 years! You can play around with historical simulations on cFIREsim or use Personal Capital’s free Retirement tools and get to your own conclusions. 🙂
Forget about it
To conclude, the best advice I can give you is to forget about it. Once you automate your savings into a proper asset allocation for your situation, simply stick to your plan and do not sell before your goal is attained. People will tend to sell when the markets are low but you should actually be buying at those great valuations!
Short-term investing is a loser’s game. As young investors, we have time on our side to profit from compound interest and capture the most of the market’s uptrend. If you think that you would be too susceptible to news events or daily swings, I suggest you start investing automatically and forget about it.
The only thing you might want to do is to rebalance once in a while but again, not according to news events.
The following years will be fun, invest properly and be smart. Be happy, Xyz.