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1/ My girlfriend has been asking for advice about how to invest for the first time. She's generally viewed the stock market as very risky, so I thought I'd share my response for why disciplined investing is such a worthwhile pursuit over the long-term.
2/ Why should I invest in the stock market?
If you open up a newspaper or turn on the TV, you won’t have to look far before you find an “expert” predicting what the stock market will do next.
If you open up a newspaper or turn on the TV, you won’t have to look far before you find an “expert” predicting what the stock market will do next.
3/ Some might forecast an impending crash while others might say the market is a rocket ship about to take off. Either way, the expert will sound confident and convincing. When enough people make enough predictions, eventually someone will be right.
4/ And when they are, they’ll be hailed as a prophet and peppered with questions about what will happen next.
The thing is, there usually is someone who gets it right…but it’s rarely the same person twice.
The thing is, there usually is someone who gets it right…but it’s rarely the same person twice.
5/ No one has ever been able to consistently time the market, and anyone who claims to know with certainty what will happen next is either trying sell you something or just sound smart.
6/ We just don’t know what inflation will be next year, or where interest rates will go, or how geopolitics will play out.
7/ And even if we did have all this information with perfect foresight, we still wouldn’t know how millions of stock market participants – each with their own risk tolerance and goals – would collectively react.
Ok, lots of cynicism.
Ok, lots of cynicism.
8/ But while these things are unknowable, here’s what we do know. We know that over the last 190 years, the stock market has ended the year higher about 72% of the time (chart 1, h/t @ukarlewitz).
9/ We know that since 1900, the S&P 500 has increased by 7,518,763%, or 9.8% per year (chart 2, source JPM).
10/ Think of all that has happened in the time period captured in that second chart: The Great Depression, World War II, JFK is assassinated, a nuclear arms race with Russia, the Vietnam War, unprecedented inflation in the 1970s, September 11th, the 2007-09 Financial Crisis,…
11/ …and now COVID-19.
There’s always something to worry about, some smart reason not to invest. Yet despite this, patient investors with long time horizons have found the stock market to be an incredible vehicle for building wealth.
There’s always something to worry about, some smart reason not to invest. Yet despite this, patient investors with long time horizons have found the stock market to be an incredible vehicle for building wealth.
12/ It’s really time in the market that matters more than timing the market.
Of course, this hasn’t been a smooth march higher. Since 1950, the average intra-year drawdown is over 13%. Chart three shows a similar pattern since 1980 (source JPM).
Of course, this hasn’t been a smooth march higher. Since 1950, the average intra-year drawdown is over 13%. Chart three shows a similar pattern since 1980 (source JPM).
13/ This means that in a typical year, the market has been down 13% from its peak at some point during the year. In the moment, this has invariably led to panicked newspaper headlines and pundits forecasting doom ahead.
14/ Yet more than 60% of the time stocks have fallen 10% or more intra-year, they’ve still finished the year with gains.
15/ Where people run into trouble is by trying to avoid these drawdowns. They sell their stocks to avoid the prospect of losing 10%, but then they fail to reinvest those savings and often miss the next 80% leg higher.
16/ Risk aversion is fine, but risk avoidance may be the riskiest thing of all.
17/ So my point is, don’t try to avoid stock-market declines. Embrace them, and remember that if your savings are down 13% at some point during the year, that’s completely normal and to be expected based on what has happened over the last 50+ years.
18/ This volatility is uncomfortable, but it’s the price of admission if you want to benefit from the enormous returns that stocks have historically generated over the long term.
19/ Ok, so when is the right time to invest?
If you’ve been sitting in cash and want to invest but are worried that stocks will go lower, that’s totally understandable. I recommend you break up your purchases and invest equal amounts every two weeks for a year.
If you’ve been sitting in cash and want to invest but are worried that stocks will go lower, that’s totally understandable. I recommend you break up your purchases and invest equal amounts every two weeks for a year.
20/ This is known as dollar-cost averaging, and it might make it easier to stomach the inevitable volatility compared to investing one lump sum all at once.
21/ You've also asked me, what should I invest in?
Investing isn’t about earning the absolute highest-return possible this year or next. It’s about generating a reasonable return with a strategy you can stick to for decades (h/t @morganhousel).
Investing isn’t about earning the absolute highest-return possible this year or next. It’s about generating a reasonable return with a strategy you can stick to for decades (h/t @morganhousel).
22/ I could recommend some specific companies that could may do well, but investing doesn’t need to be complicated. I think the best strategy for you is to invest in a low-cost index fund known as an exchange-traded fund (ETF).
23/ To be honest, as long as you’re a patient and level-headed investor taking balanced risks, that’s going to matter more than what specific fund you invest in. Your savings rate will make a much bigger difference than choosing the right fund.
24/ That said, here’s my recommendation. Whether you invest through Schwab or Betterment, I think your main investment should be the Vanguard Total Stock Market ETF (ticker: $VTI).
25/ VTI will give you diversified exposure to the 3,000 largest companies in the US, with close to zero fees. It’s a “passive fund” which means no one is actively picking stocks – it’s just designed to mirror the broad market index.
26/ Note the index is weighted by market capitalization, meaning larger companies carry higher weights. As a result, five tech companies (Apple, Amazon, Facebook, Microsoft and Google) account for 19% of this ETF.
27/ As a shareholder of VTI, you will be a partial owner of America’s 3,000 largest businesses. By investing your savings, you will have a small but very real stake in each of these companies.
28/ You can change your LinkedIn profile to the flex: “Owner of 3,000 Businesses.”
But really, these aren’t just pieces of paper – these 3,000 businesses together represent the majority of America’s economic activity.
But really, these aren’t just pieces of paper – these 3,000 businesses together represent the majority of America’s economic activity.
29/ They own manufacturing plants, patents, factories, brands, media rights and valuable assets both tangible and intangible. They include Disney, Starbucks, Nike, and smaller companies that may someday become household names.
30/ These companies will have good years and bad. When you think of them as abstract stock tickers on your computer screen, this sounds risky.
31/ But history has proved time and again that American businesses in aggregate have emerged from crisis even stronger and more capable than before.
32/ Keep in mind that stocks (pieces of paper) fluctuate much more than businesses (tangible enterprises). When the stock market was down 35% in March, was the collective value of all American businesses worth 35% less than it was just a few weeks before? No way.
33/ So just remember that the price you see on the screen of your account today does not necessarily reflect an accurate value of what your companies are worth. But as long as businesses continue to invest and grow, the benefits will flow down to shareholders like you.
34/ As a patient and long-term investor, you’re simply betting that this progress continues as it has for hundreds of years. Let the shorter-term investors worry about what happens to the stock market next month or next year. Over time, the optimists always win.
35/ This was written for a first-time investor, but it helped me clarify my own investing philosophy. I'll be forever grateful to people like @morganhousel, @jposhaughnessy, @awealthofcs and @michaelbatnick for sparking my initial passion for investing several years ago.
