On Monday, March 9, the stock market saw the biggest crash in history as the Dow Jones Industrial Average fell by over 2,000 points. The coronavirus pandemic proved to be just as detrimental to the stock market as the Great Depression or the 2008 financial crisis.
Yet, only a month later, the stock market had its best week since 1938, even though 16 million Americans lost their jobs at the same time.
Many businesses, big and small, fear for their survival and hope that government grants and bailouts can keep them afloat. Protestors across America demand that the economy re-open even though the U.S. has the highest number of reported coronavirus cases around the world.
Yet, the stocks keep climbing up even though some investors worry that another crash is right around the corner.
So investing is clearly a scary prospect. After all, the market could decline again and diminish your assets. Is it better to just keep the money in the bank rather than tying it up into assets?
The answer, quite simply, is no.
You should invest any money you don't need, especially if you're young. Investing the perhaps the best way to ensure that you'll live comfortably when you're old.
However, only 37% of Americans 35 and under have money in the stock market, according to a 2018 Gallup Poll. Similarly, a GOBankingRates survey found that 55% of Americans believe they don't have enough money to invest.
Not investing is one of the biggest financial mistakes anyone can make. You need to ensure that your money will work for you throughout your life, especially if you want to retire.
Still not convinced? Well, continue reading.
Investing Isn't Like Gambling
One of the most common concerns I hear is that investing is too much like gambling. Sure, I see some similarities. Both involve putting your money into something that could result in losses. However, there's one big thing that makes investing different: the odds are in your favor.
Historically, stocks go up. Look at this chart of the S&P 500 since its inception.
If you put your money into the S&P 500 at nearly any time in history, you would've eventually made a profit as long as you didn't sell.
That's why newbie investors should strongly consider buying index funds such as $SPY and $IVV. Owning an index fund essentially means you own a bit of every company in the S&P 500. You'll get a tiny piece of big names such as Apple, Google, Amazon, and Facebook, as well as smaller companies like Hasbro, Chipotle, and FedEx.
On average, the S&P 500 gains about 7% each year.
Buying individual stocks is a lot riskier. Most investors look for stocks that can "beat the market" and return higher than the S&P 500's annual 7%. This works out very well in some cases. Anyone who bought Netflix or Disney ten years ago would've made back their money fivefold.
However, many stocks fall from great heights and never recover. Blue Apron was worth $140.10 at its IPO and is now worth less than $8.
In short, index funds are your friend. Even billionaire investor Warren Buffett believes that most investors should stick to index funds because they're much safer than individual stocks. Index funds provide diversification, meaning that you're not putting all your eggs into one basket. Buying individual stocks can potentially provide even greater returns, but you should research whatever you buy first.
Exchange-traded funds (ETFs) are another way to diversify. Many ETFs capture specific markets or industries. For example, you could buy an ETF focused on healthcare or one which tracks companies in Sweden.
Time in the Market > Timing the Market
This old adage is one of the principles all investors should follow. Too many people think they can wait until the stock market hits its bottom before investing. We'd like to believe that we all have such foresight, but the market is nearly impossible to predict.
However, one thing remains clear: the longer your money stays in the market, the more you'll earn. That's why it's best to start investing at a young age.
A NerdWallet analysis found that a 25-year-old millennial who earns $40,456 a year and invests 15% of their savings could potentially make $3.3 million by the time they retire. This hypothetical investor only spent $563,436 over their lifetime and retired as a multi-millionaire.
Thanks to compound interest, getting into the market earlier means you'll likely achieve higher returns. Those who wait and invest later in life often end up missing out on huge potential profits.
Your Money Isn't Safe in the Bank
Most people worry about losing money in the stock market, so they keep their savings in the bank instead. However, what they don't know is that they're still losing money anyways thanks to inflation.
According to the Federal Reserve, 2% is a healthy core inflation rate. That means that the prices of goods and services will be, on average, 2% more this year than they were last year. One dollar in 2020 would be worth roughly $26 in 1913. Back then, you could spend a few quarters and purchase your entire grocery list along with some personal care products.
The dollar will continue to decrease in value as long as inflation grows. I used NerdWallet's inflation calculator – which assumes the annual inflation is 2.5% – and found that $100 in 2020 will only be worth $37.24 in 2060.
On the other hand, investing $100 in the stock market with an estimated 6% annual return (adjusted for inflation) would give you $1,028.57 in the same time frame.
While you might lose money in the stock market, you will lose money if you don't invest.
Dividends Are A Great Way of Passive Income
If you're worried that your stocks won't make money, try dividend investing. Many companies earn so much extra money that they pay their investors a small fraction each year as thanks. You'll get a little bit of cash each year, regardless if the stock goes up or down.
However, be careful of falling into a high yield trap. It might be tempting to invest in companies promising dividends of 50% or more, but these are usually highly unstable companies that aren't worth your money. Companies can cut dividends at any time and will do so when they're losing too much money.
As a rule of thumb, a good dividend stock will yield between 1% and 4%. Some stable companies might pay even more, but you should do some research to make sure they're worthy investments. Simply Safe Dividends is a great resource to check a stock's dividend safety. You can try a risk-free two week trial with them if you want in-depth dividend information.
You also want to look at a company's payout ratio – defined as how much of a company's earnings go back to investors. You can calculate a company's payout ratio by dividing the total dividends per share by the earnings per share. But if you'd rather not do the math, you can just look up the company on Marketbeat. Healthy payout ratios are between 35% and 55%. Anything over 75% is risky.
Still not sure what to buy? Here are two solid ideas:
The first is blue-chip stocks. Blue-chip stocks are the established names that have been around forever and have a proven track record of increasing returns. Some popular blue-chip stocks which pay dividends include 3M, IBM, Home Depot, Apple, Coca-Cola, and Disney.
The second is dividend aristocrats – stocks which are in the S&P 500 and have been increasing dividends for at least 25 years. Some great companies include Exxon Mobil, Clorox, AbbVie, Johnson & Johnson, and McDonald's. Many of these companies are also blue-chip stocks.
However, not all companies pay dividends. Many firms, especially startups and tech companies, prefer to invest that extra money back into the company. These stocks still provide a prime investment opportunity as they might outpace their dividend peers in price growth. Some examples of great dividend-less companies include Tesla, Facebook, Shopify, Google, Amazon, Netflix, and Autodesk. These are all fantastic companies, even if they don't provide passive income.
If you want to learn more about dividend stocks, I'd highly recommend Andrei Jikh's YouTube channel.
Social Security Isn't Guaranteed
The 2020 annual report of the Social Security Board of Trustees revealed one scary fact: its trust funds may run out of money by 2035. A trust fund allows Social Security to maintain enough revenue to pay out its beneficiaries. When baby boomers inevitably leave the workforce and retire, Social Security will suddenly find themselves having to pay out a lot more people with a lot less money to do so. This is terrible news for both current and future retirees.
Luckily, there are other retirement options available such as IRAs and 401(k)s. The only problem is that most Americans don't invest in those either. One GOBankingRates survey polled 2,000 Americans and found that about 46% weren't investing in retirement funds.
The sad fact is that most Americans will retire broke unless they start doing something now. Most people might end up spending their golden years struggling instead of living their dreams.
If your work offers a 401(k), take full advantage of it. If your job offers a match, you should take that offer or else you're missing out on free money. Many companies will automatically enroll workers in 401(k)s to ensure participation.
You should also create an IRA, even if you already have a 401(k). An IRA will give you extra leverage for when you reach retirement age.
You can choose between a traditional IRA and a Roth IRA. The main difference is that traditional IRAs will tax your withdrawals, but Roth IRAs will tax your contributions. You just have to decide if you prefer to pay taxes now (Roth IRA) or later (traditional IRA). Either way, you should contribute the maximum amount every year.
You Don't Lose Until You Sell
Here's one more reason investing is different from gambling: you decide when you want to take a loss or hold it out. In gambling, your money could be gone in an instant when you bet on red instead of black. In investing, you only lose when you decide to sell your shares. If you're a long term investor who wants to buy and hold stocks, you won't need to pay attention to the market's ups and downs. You're here to ride out the wave for at least a decade.
Remember when Facebook got in trouble for selling user data to Cambridge Analytica? The company lost $120 billion in market capitalization, and the stock dropped 19% to $176.26. At the time of this writing, Facebook is worth $204.71 – a $28.45 gain. Anyone who sold at that time lost money, but those who held made it back.
That's not to say that you should always hold onto your losing stocks. Remember the example of Blue Apron earlier? I'm no financial expert, but I doubt anyone who bought it at $140.10 will ever make their money back.
If you made a bad bet (and I've made plenty), not all is lost. You can turn your lost money into tax savings. The IRS allows investors to write off $3,000 worth of stocks each year to offset any gains from sold stocks and dividends. You can carry losses over that $3,000 until the next year.
For example, if you made $10,000 in the stock market and lost $3,000, you can harvest your losses and only pay taxes on $7,000.
Investing is a marathon, not a sprint. The average person's lifespan is about 79 years old. That number, like compound interest, is slowly rising over time thanks to advances in medicine and technology. Will you have enough money to stay afloat in your old age?
Think about each stock purchase as something that will be with you for the rest of your life. In the words of Warren Buffett: "Only buy something that you'd be perfectly happy to hold if the stock market shut down for ten years."
Look at your budget and identify areas where you can save a little bit more. Some financial gurus suggest putting 15% of your income into the stock market, but it never hurts to add a bit more. Setting aside a few bucks here and there can ensure that you'll live a prosperous life without worrying about financial problems.
With the stock market at record lows, now has never looked like a better time to buy.