Updated: Jun 17, 2020
If you're nervous about putting your money in the stock market, you're not alone. (Sorry, the following stats are written about millennials, I know I'm not the Frugal Millennial! But somehow we are too young to have our own statistics out yet). Less than 1/3 of millennials have money in a 401(k) and less than 1/5 even have an individual investment account.
And this response makes sense, given that millennials grew up with the 2008 stock market crash. They saw families and friends "lose" (I'll get to that later) all of their life's savings. 1 in 3 millennials has significant credit card debt. Plus, the average college graduate has about $30k in student loans. We also earn 20% less than baby boomers did at our age, taking inflation into account.
So yeah, I know. Things weren't easy pre-2020 and things sure haven't improved over the last 6 months.
But if you follow these 3 sure-fire ways to avoid losing your money, you will not only keep your hard-earned dollars, but grow them. Remember, keeping your money in a savings or checkings account is 100% guaranteed to lose money, because the interest rates don't even keep up with inflation. So instead, follow these guidelines and invest your money in a low-fee index fund...
Yep, diversification is the most annoying financial buzzword. But, like splurging for comfortable shoes or not drinking Four Loko, the advice is sound. Diversification just means investing in several or many different areas, in case one does particularly poorly. It spreads out your risk.
If you had put your life savings into floppy disks in 1980, that would have sucked. You probably would have lost all your money. This is the simplest example of why we need to diversify. We never know what product, company, sector (like oil or pharmaceuticals), or country is going to collapse next. So to be safe, never choose one single product, company, sector, or country to invest in.
So, what does diversification look like in an investment account?
Put most of your money into indexes. This avoids betting on individual stocks and lowers risk.
Have a few indexes, like a U.S. index fund and an International index fund. A commonly recommended divide for an aggressive growth portfolio (which we all probably want, at this point) is 60% U.S. stocks, 25% international stocks, and 15% bonds.
Have at least a few bonds! Bonds and stocks tend to thrive at opposite times, so if your stocks are down, it's nice to have another investment that's up. When you're starting out this isn't that important, but it is vital by the time you're approaching retirement age.
2) Don't take it out!
I'm only going to say this once. Or twice.
OVERALL, ON THE WHOLE, the stock market goes up.
But, but what about 2008?
2008 is one year. Yes, the stock market did terrible things. It plummeted. It was unprecedented. But guess what? It rebounded 100% within two years.
This is what the Dow Jones index has looked like over the last one hundred years (up until 2017).
In the scheme of things, recessions are blips. They are short-term and the money always comes back. History has proven this time and time again.
The thing to remember is that if you take your money out of the stock market, you are accepting the amount of money you have as final. You will start again from that amount if you choose to re-invest. If you ride the market on the way down, you MUST stay in and ride it back up. The only reason people lost money in the 2008 crash, long term, is that they pulled their money out when its value was at its lowest. They kept their money in when the stock market went down, and pulled it out before it went back up.
If the market is doing well, and you want to pull your money out -- to spend it, or try to avoid a recession (good luck), or because you're happy with the money you've made -- go for it! But there is NO GOOD REASON for pulling money out when the market is down, unless you plan on immediately re-investing it somewhere else (like to change index funds).
So, the most important rule of investing:
Ride the waves.
3) Don't time the market!
This is more of a recommendation. If you majored in economics or are a CFP or have an advisor, feel free to ignore this one. But if you are managing your own money and aren't super confident, DO NOT try to time the market.
What is timing the market?
Timing the market means anticipating what the stock market will do next, and making investment decisions based on that. To be successful, you would want to invest when the stock or fund is at its lowest, and pull the money out when it's at its highest.
If you saw the following DJIA graph, what would you predict will happen next? Would you pull your money?
Probably not, if you were a normal American.
Oops.... Welcome to March 2020, the most insanely unpredictable and, don't forget, ***unprecedented*** time of our young lives.
No one except lucky old geniuses can time the market. You are just as likely to lose money or end up with the same amount.
Instead, I recommend a method called Dollar Cost Averaging. This is a complicated sounding concept that really just means putting the same amount of money into the stock market regularly.
For example, maybe you'll put $500 into an S&P 500 index fund every month in your IRA. Don't change your mind based on whether the market is high or low currently, just do it! This method actually works out well (and not just because you're sticking to a plan and putting money in). It's particularly smart because your $500 will go further when the market is lower, so you'll be able to buy more shares with the same amount of money.
Thus, you'll buy more shares when the market is low, helping you ride the waves upward with the stocks. Wow, that was a terrible convoluted metaphor.
How do you protect your money? How worried are you about the next recession?