How Should You Invest?
By Brett Sifling
Investing is really hard. There is so much noise in the modern investing world, what is the right approach for a young investor?
As an investment advisor with Gerber Kawasaki, my job is to take a holistic view of people's finances and help them construct plans to meet their goals. The truth is, there is no magic formula. Each individual has a different financial situation, risk tolerance, and specific goals. Investing requires a dynamic approach and without the proper guidance, you will likely find yourself overwhelmed and probably underperforming.
In this article, I will cover some of the popular investment classes and their place in a young investor's life. From owning stocks to speculating on cryptocurrencies, what does it all mean?
When you are young, you should consider investing more of your money into stocks because you have time on your side and you can weather the bear markets. The more time you have to invest, the more risk you can take on. Stocks simply represent ownership in a company. It is very important to understand that you are buying businesses, not ticker symbols. Stocks have historically been a major engine for growth in a portfolio and a solid hedge against inflation. However, stocks can be risky and extremely hard to predict over the short term.
Over the long term, the S&P 500 (one of the most widely used stock market benchmarks), has averaged about an 11% gain per year. The index has proven that the longer you stay invested, the less likely you are to lose money in the stock market. In fact, if you stayed invested in the S&P 500 over any 15 year rolling period (a consecutive 15-year period), you would never have lost money in the last 70 years. Most people lose money by trying to time the stock market downturns, but end up buying and selling their way to underperformance.
Furthermore, in order to survive and manage your downside during unpredictable short-term downturns, you should avoid using any type of leverage or debt to place investments. The concept of borrowing cheap money to boost gains has become very popular over recent years. Drawing wisdom from Warren Buffett's 2018 letter to shareholders, "Even if your borrowings are small and your positions aren't immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions."
Bonds are the safer investment class. When you purchase a bond, you are simply loaning money to a government or corporation. In exchange for your loan, they will preserve the principal and pay you a specific rate of interest. Bonds are great for safety and stability within your portfolio. However, the returns have historically been much lower than stocks and they often risk not keeping up with inflation. They are a risk-averse asset and should only be a small part of a young investor's portfolio. As you get older, bonds will become more prominent as you take on less risk near retirement.
A major risk of owning bonds right now is "interest rate risk." When interest rates rise, bond prices fall. This can be problematic if you are trying to sell a bond before it's maturity date, since you will likely sell it for less than you paid. We are currently in a rising rate environment and the fed expects to raise rates three times this year.
You probably have friends that claim they are getting "rich" off of cryptocurrencies. This new investment class has ballooned into a market cap of nearly $500B. What exactly are they investing in? Everyone has a lot of questions about this new blockchain technology and its place in our society. Just like the dot-com bubble in the late 1990's, there has been excessive speculation and wealth creation resulting from this cryptocurrency buzz. Speculation should not be confused with investing and runs the risk of losing most or all of your money.
Were the early crypto investors just lucky? Only time will tell. There is no doubt that blockchain technology will change the world, but most of the specific cryptocurrencies will likely fail. When you are investing in such a new technology, it boils down to speculation as investors hope these companies will one day become profitable.
When speculating on a new technology such as cryptocurrencies, it is unwise to risk any more than 5% of your total net worth. Unlike stocks, investing in specific coins is not owning equity in the company itself.
Where to Start
When it comes to investing, every person's situation is truly different. The general rule is that the younger you are, the more risk you can take, but that should not be taken literally. If you are wondering what your perfect mix of investments should be, please reach out, I can help! My firm does research on thousands of different investment options and can help create a plan specifically designed to you.