Millions of Americans are getting new stimulus checks, and the financial commentator Suze Orman is concerned about what you’re going to do with it.
“Don’t you dare use it to invest in the stock market,” she quipped recently, along with various other “don’t”s.
Putting aside the efficacy of “don’t” forms of financial advice for a moment, the idea that the “stimulus check class” shouldn’t participate in the market isn’t just snobbish and exclusionary, but also condescending.
Over the past century, the stock market has been a useful saving tool, something that has been even more important since pensions turned into 401(k)s, putting the burden of responsibility of saving for retirement on workers.
All of this may be deeply flawed, but the stock market doesn’t have to be a mysterious beast that eats all your money, especially if you know the difference between investing and speculation. Many people will doubtless learn these lessons the hard way, but here are some things to know if you’d rather take the easy way.
Long term vs. short term gains
Every investor has a “silent partner” in investing, as Ritholtz Wealth Management’s Barry Ritholtz likes to say. The partner is the government, because, just like your wages, federal, state, and potentially local governments get a piece.
This matters a lot when you’re talking about long-term investing versus short-term investing, because owning an asset for more than one year before selling it (the difference between a long-term and short-term investment) means you pay less in taxes than you would have if you sell an investment before the year is up.
You’ll owe Uncle Sam up to 20% on a long-term capital gain, depending on your income, and possibly more for a short-term gain, enough in many cases to cancel out some of the gains. There may not be a lot of fees now thanks to Robinhood and its influence on the brokerage industry, but frequent trading probably means some short-term positions, which means any profit has to be that much bigger to beat a typical benchmark like an S&P 500 index fund.
The longer the better
No one knows what the market will do, but because global economies are growing, the stock market has a good shot of going up over a longer period of time. In fact, the longer the better.
Historically, a longer time horizon means you will probably have enough good times to make up for the inevitable bad ones that come every so often to disrupt the market (last March, for example). For example, thanks to some good analysis from Credit Suisse, investing in the broad market (via an S&P 500 index fund) for a period of 16 years or more at any time resulted in no negative returns.
But not only was that no negative returns, but being in the market for a longer time allows for compounding, a factor that works like snowballing. This is the most powerful force in finance and it can be yours to harness. All you have to do is nothing. The problem, obviously, is that you don’t get rich quick. But usually you do get a bunch of money with an approach like this.
Stock picking is really hard
The most classic market conversation is about which stocks to buy to make you richer. But a close second is the one about how investing in the stock market via an index fund usually works out better than trying to guess.
Warren Buffett, one of the best stock pickers of all time, literally tells everyone not to pick stocks and to buy an index fund instead. Active managers underperform passive managers (passive means the index composition determines what to buy, not the manager). In fact, this year marks the 11th straight year that most active managers didn’t do as well as the indexes they track.
If you’re really good at stock picking, that’s great, but it might just be luck. Furthermore, it takes a long time to find out, since we’re talking about the long-term. If you like stock picking as a hobby, and feel like you have an investing thesis that cannot be done justice through diversified index funds, go right ahead. But it’s good to be clear-eyed that it’s a difficult thing to do.
The other aspect of that is, if you don’t like investing but would like to invest, an index fund does all the work for you. Buffett, who says he’ll put his bequests to his family in an S&P 500 index fund, is able to communicate his investing wishes in a single sentence. For someone who wants to get into the market, you can get a diversified, extremely cheap option in this fashion, with minimal work.
You’ll see declines in the market
In a typical year, the market often has a decline. It’s unpleasant for anyone, but know that most years that finish with gains have had declines too. In this chart from JPMorgan’s Asset Management division, you can see that most years have a bit of “turbulence.”
Volatility is an inherent part of the market, which is also a reminder that you’re in a better position if your immediate cash flow needs are met so that you don’t have to sell at an inopportune time if you’re short on cash.
Timing is just as hard as stock picking
Not only will stocks fall, you don’t know when they will and you don’t know when they’re going to reverse. Today, there are countless people who got out of the market at the beginning of the coronavirus crisis — perhaps even missing the big crash in March. But how many of these investors decided to get back into the market afterwards? How many of them could have foreseen that even in the midst of crisis the stock market had completely recovered and returned to an all-time high? How many of them would have expected the best 100 days of all time for the stock market?
“If an investor pulled their money from the market during last year’s volatility, there have been a plethora of reasons to be hesitant to reinvest it, and the subsequent bounce from the lows happened in a flash, meaning they may have bought back in at a higher price than they originally sold,” LPL’s Ryan Detrick wrote in a note this week.
One statistic that gets shared every so often — for a reason — reminds people of how damaging it can be to miss just a few good days in the market. Missing the best 10 days of the stock market from 1999 to 2018 would bring lower results from 5.68% to 2.01%.
The market can still go up even if it’s at an all-time high
“Why invest now?” some people might say, noting the market is currently flying. But it’s been pretty much “flying” since the crash. We have been around an all-time high frequently, and all-time highs are often followed by new all-time highs.
A simple glance at the stock market chart tells this story well. While there are plenty of teeth, you can see how one high turned into a new high, which turned into yet another new high. Yes, you might invest and then immediately lose some money, but that’s how it works.
After an all-time high, the average returns three months after were 1.5 %, 4.0% after six, and 8.3% after a year.
“Bottom line,” Detrick wrote last year, “many investors are scared of new highs, but they shouldn’t be.”
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Ethan Wolff-Mann is a writer at Yahoo Finance focusing on consumer issues, personal finance, retail, airlines, and more. Follow him on Twitter @ewolffmann.