The year 2022 has been a time of great uncertainty for investors with periods of extreme volatility.
Below are eight investment insights to consider during these uncertain times:
Volatility is “The Price of Admission”
Successful investing requires having an “investor’s mindset.” This means being able to accept market volatility. Which means not expecting investments to provide a guaranteed returns (like a certificate of deposit) and no loss of principal. An analogy is that volatility is a “fee” charged to investors; who must be willing to “pay” it (i.e., remain invested) to gain access to potentially superior long-term returns.
Long-term investing is a good antidote for high inflation because it has potential to provide returns that exceed what inflation and taxes take away.
Thereby maintaining purchasing power and preserving wealth.
The key is to hang tough when there is bad economic news. While it is emotionally difficult to “stay the course,” market downturns actually provide a great buying opportunity similar to deep discounts on products sold online or at department stores. A recent book by financial blogger Nick Maggiulli advises readers to Just Keep Buying (i.e., making investing a habit).
Research by the Consumer Federation of America found that people with a plan saved more successfully than those without a plan. A plan was defined as “a savings plan with specific goals.” Another study found that retirement provided a powerful motive for regular saving/investing. This speaks to the importance of setting goals and saving/investing for multiple goals (e.g., retirement, college, a car) concurrently with different “buckets” of money.
Some Investments are Already Diversified
Diversification is the process of investing in different securities to hedge the risk of loss affecting any one of them. Researching, purchasing, and monitoring multiple individual securities requires time and investment expertise.
A much simpler, as well as less expensive, way to achieve diversification is to select a stock index mutual fund; or exchange-traded fund that provides broad stock exposure. Examples include total stock market index funds that track U.S. stock indexes. Another is total world index funds that provide exposure to stocks issued worldwide.
Compound Interest is Not Retroactive
People cannot earn interest on money that is not invested; which often happens when people get a late start investing and/or “sit out” stocks during market downturns. (i.e., in an attempt to practice market timing) The latter helps explain results of a Dalbar study of the difference in performance, as well as the growth of, $100,000 between the average equity investor and the Standard & Poor’s (S&P) 500 index between 1/1/92 and 12/31/21.The S&P index returned 10.65% resulting in $2,082,296 after 30 years. Average investors earned 7.13% and accumulated $789,465.
Bottom line: investors under-perform market indexes when they are out of the market too often.
The First Million is the Hardest
Like the game show Who Wants to Be a Millionaire?, initial rounds of the investment “game” do not double large sums of money. However, you must get through them for compound interest to double larger amounts later.
Most people do not become millionaires until their 50s or 60s after they have been investing for 30 or 40 years. Late starts and “sitting out” down markets only delay investment growth. Once you accumulate $1 million, the next million might only take a decade or so (Rule of 72: money earning an 8% average return would double in about 9 years).
Financial Capital Can Replace Human Capital
Economists refer to the knowledge, skills, productivity, and other personal attributes that people bring to a job as “human capital.” Human capital helps people earn a living; but it wanes over time as people age. Investing can help people turn their human capital into financial capital. For example, withdrawing 4% of an $500,000 investment portfolio in later life is equivalent to earning $20,000 ($500,000 x .04).
Financial Independence is the Ultimate Goal
Financial independence (FI) is the state where people can pay their bills. They can have the quality of life that they desire without having to work for others. Many people try to achieve FI before they retire, whether this occurs in their 50s and 60s or 30s and 40s (FIRE proponents). FI occurs when monthly investment income (supplemented with guaranteed income sources, if any) exceeds monthly living expenses. The classic book Your Money or Your Life refers to the time when income from investments surpasses expenses as the “Crossover Point.”