Thursday, October 16, 2008

Advice to Young Investors

The recent market crash has wiped out trillions of dollars in (paper) wealth, crippling consumer confidence and quite possibly tipping the upcoming election in favor of Barack Obama. Economists and journalists everywhere are weighing in on the situation, analyzing it from all possible angles and viewpoints—advice, reassurance, warning, criticism, etc.

As a young investor, I have a different perspective on the meltdown from most of these pundits. I’m not an expert, and I don’t presume to be able to talk intelligently about the complex web of financial blunders that led to the crisis. But I have learned a few lessons from the events of the past few weeks, lessons I hope others will take to heart as well.

I’ve been investing for about 10 years, ever since my Bar Mitzvah, which was the first time I had money to invest. Initially I invested only in small amounts, keeping most of my savings in a interest-bearing account at the bank. Gradually I put more and more money into the market, until about 90% of my savings were tied up in non-liquid assets.

This was mistake number 1. Balance is key. Stocks are volatile by nature, and even the most daring investor should reserve at least a quarter of his assets for conservative, liquid investments like CDs and bonds that are more resistant to economic downturns. My exposure to the dangerous swings of the stock market was far too great, and now I am suffering the consequences.

Lesson number 2: sometimes, it’s good to sell. Even a young investor should take a profit once in a while. Generally it’s good to think long term, but I took this good piece of advice too far. When the market was around 14,000 last summer, several of my investments were up 20-30%. Even though it’s impossible to know exactly when the market is peaking, history showed that a correction was coming. Rather than holding out for greater growth, I should have sold a portion of my gains, in order to secure some profit. Instead I watched as their values slid lower and lower, until they were worth half as much as I originally put in.

Conversely, you shouldn’t buy too soon. As the market declined, I kept feeling the urge to capitalize on the slide by buying stocks that had seen heavy losses. I’d see a stock nearing its 52-week low (Target, for instance) and think, “Gee, I’d better buy some of that before it turns around!” And I would, completely ignoring the fact that the market has been in a bull market for four years (meaning a 52-week low was really not a good indicator of its floor), so there was no good reason to think the stock wouldn’t drop right through its low. And it did. Target, Adobe, and Whole Foods were all stocks I bought near their low, and are all now well below that number.

Last week the market stood nearly 40% lower than its peak, a remarkably steep and sudden fall. For long-term investors, now is the time to start buying up beaten-up companies (General Motors, GE, certain banks, etc.) yet I don’t have the cash to take advantage of this rare opportunity. Since selling stocks right now would mean taking a real loss of money (rather than a paper loss), it would be unwise to do so now. Buy low, sell high is one truism that is never wrong.

It seems that humans (particularly feverish stock-owning ones) have the tendency to see the economy on a very limited timescale, and to underestimate the time it takes for economic cycles to occur and recovery to begin. Especially when you’re young (and have experienced mostly strong market performance) it’s easy to fall into the mental trap of believing things will improve quickly. On the contrary, the economy is a large, slow-moving ship, and it takes time to turn it around. This is even more true these days, with the perfect storm of rising commodity prices, declining home values, a default-ridden mortgage industry, job cuts, and a shaky stock market coming together to bring the economy to its knees.

All in all, investing in stocks is still a good idea for young people. We have fewer expenses and responsibilities consuming our money, and more freedom to be risky with our investments, knowing we have the time to weather downswings and extreme volatility. For sure, it’s never to early to start a 401K retirement fund—the difference between starting at age 20 versus age 30 or 40 is tremendous, due to the effects of compound (that is, exponential) interest.

So to all the terrified young investors out there, don’t let your fear control you. They say Wall Street is run on two emotions (fear and greed), and if you learn to keep them in check, you’ll always come out ahead. It may seem strange, but this is the best time to start investing. Witnessing a historic crash such as this leaves a profound impression on one’s financial disposition, and should help keep our generation from repeating the mistakes that got us here in the first place.

No comments:

Post a Comment

Note: Only a member of this blog may post a comment.