Have you ever sat through a family dinner and had to listen to your parents curse the stock market? Mmhmm, me too. If they are anything like my parents, you won’t hear about how the markets are responsible for their comfortable retirement, but you will hear about how the markets are going to put them in the poor house. Flair for the dramatic? Maybe. But they aren’t entirely wrong. Down markets aren’t great for people who are nearing or in retirement because they don’t have time to recover. However, that’s not me. And I’m guessing it’s not you either. Investment advice for millennials is different. We still have time on our side, and that means down markets are actually a good thing!
Don’t Believe Me, Here’s the Math!
Let’s break it down by the numbers so you can see what I’m talking.
Here’s the scene: we have two hypothetical 30-year-olds investing in two hypothetical but very opposite market conditions. Millennial number one, I’m going to call her Ashley (common millennial name game), is super pumped because she’s new to investing and the market is CRUSHING it. Millennial number two, I’m calling her Sarah (because I want to be the winner and it’s another super common millennial name), is also just starting out and is feeling a little unsure because the market is pretty mediocre.
How are things going to turn out for Ashley and Sarah?
Both of them are starting with no money saved and are planning to start investing $1,000 every month. You go girls. But the difference comes when we look at their rates of return. We’re flashing forward 20 years and looking at their financial picture when they’re 50. Ashley earned an average 10% rate of return in her first ten years but then earned an average 5% rate of return in the next ten years. Sarah, on the other hand, earned an average 5% return for the first ten years and then an average of 10% for the next ten years. Obviously, these are oversimplified conditions, but it’s not that strange for the market to go on a good run for a few years and then a not so good run.
After ten years of investing, Ashley will have $199,863 (AMAZING!) and after 20 years that will have grown to $479,920. Sounds pretty damn good right?
Well, not so fast.
For Sarah, she will have $154,363 after ten years and (wait for it) a whopping $600,242 after 20 years. That’s over $120,000 more than Ashley simply because the markets were worse earlier than later.
Consistency is Key
At the end of the day, what happens in the markets is out of your control. So sure, Sarah ends up ahead in this situation, but a lot of that has to do with luck. No one knows what events the market will be reacting to thirty years after they’re born.
The most important lesson you should take from this is that investing money EVERY SINGLE MONTH is always the right option. Both Ashley and Sarah invested $1000/month for 20 years. That means they each saved a total of $120,000. When you look at their end totals, they’ve both done well, and compounding has helped big time.
When you use the strategy of contributing every month no matter what the markets are doing, you’re doing what is called dollar-cost averaging. What does that mean? By investing at different intervals, you will be buying at different prices. Let’s say one month you buy a stock with a price of $40 per share and then the next month you buy that same stock at only $30 per share. You’ll now hold double the number of shares, but your average purchase price will be $35. This can be an excellent way to limit the effects of volatility on a portfolio over time.
This is how many of us invest because it’s easy to line up your investments with your pay cycle. But is that the best strategy if you get a lump sum of cash? Well, no. Vanguard conducted a study on dollar cost averaging versus investing a lump sum and found that the lump sum option outperformed two-thirds of the time. That doesn’t mean you should hoard your cash so you can deposit a lump sum. The best practice is to invest the money as soon as you can. If you have a spare $1,000 a month, then invest $1,000 a month. If you get a hefty tax refund once a year that you want to invest, then invest it right away. Keeping your money out of the market rarely gets you ahead when we’re looking at long-term investing. If you’re going to need the funds in the short-term, then that’s a very different situation, and you should keep it safe and accessible.
Don’t Fear Down Markets (when you’re young)
While your parents may be complaining about the recent ups and downs in the market, you should embrace it. Every time you invest money when the market is down, it gives you a better chance of beating the average and coming out even further ahead.
The old cliche of buying low and selling high is working in your favour. For your parents, it’s the opposite. It’s completely different when you’re on the selling side, as I’m sure many of our parents are. I know my parents withdraw funds from their investments every month to fund their lifestyle in retirement. That’s not ideal when the markets are markets are up and down. And they’re lucky; they both have pensions that provide stable income.
Reducing Risk As You Age
The older you get, the more impact a down market is going to have on your investment portfolio. Why? Because you have less time to recover. That’s why you want to reduce the risk on your portfolio, the closer you get to retirement and switching from depositing to withdrawing.
I’m not going to go into great detail here about building a well-balanced portfolio, but it’s all about how much you have invested in bonds (the safe stuff) and equities (the riskier stuff). If you’re investing as a millennial with decades until retirement, you can take on more risk by having more equities (maybe 80-90%) and fewer bonds (10-20%). As you get older, you can start balancing out those proportions a bit by trimming your equity positions and increasing your bond exposure. This will help you grow your money now and lessen the impact of a down market in the future.
So, don’t always listen to your parents when it comes to investing and don’t get scared off when all you hear is negativity around the markets. The best investment advice for millennials is not to fear down markets, and instead, realize that they provide you with opportunities.
This post was proofread by Grammarly.