May 11, 2022
Today’s market may feel like terra incognita for young investors.
Inflation is up, markets are down. Older investors may recall 1981, the last year consumer prices rose this quickly and stocks fell, but not so investors under 40, who weren’t even born then. And while some younger investors may remember the financial crisis and the dot-com crash, those momentous events didn’t coincide with torrid inflation.
Although older investors have more experience dealing with portfolio-eroding market shocks, younger investors have a critical advantage: time.
If you’re 40, you likely have about 25 years until retirement—plenty of time for the markets to recover and resume their long-term growth trajectory. During that period, you can benefit from compound returns, which can turn small sums into big nest eggs.
“It’s not about timing the market; it’s about time in the market,” says financial advisor Laura Steckler of Raymond James Financial.
For this and other reasons, Americans in their 20s and 30s may have good opportunities to invest now and make tactical changes to their portfolios, financial advisors say. The key is to do so prudently, which means ignoring risky fads like meme stocks, crypto, and options trading, and brushing up on the basics.
Here are a few scenarios in which trusts can be used by families that are not necessarily in the top decile of wealth:
Fundamentals
Times like the present, when macroeconomic uncertainty abounds, underscore key tenets of financial planning. So before younger investors start or add to their nest eggs, they should set aside an emergency fund to cover three to six months of living expenses. A high-yield savings account allows investors to earn interest on those funds while keeping them accessible.
Next, investors should make the most of tax-advantaged retirement accounts, such as 401(k)s and IRAs before they consider other investments. And they should always take advantage of matching employer contributions. Not doing so is the equivalent of rejecting free money. Let’s say an employer matches employee 401(k) contributions of 4% of their salary. For the worker earning $50,000, that’s $2,000 a year.
So what to invest those retirement plan savings in? Target-date funds may be appropriate for first-time investors who prefer a set-it-and-forget approach, advisors say. Investors can pick a fund that corresponds to their expected retirement year. Over time, the fund automatically shifts its allocation from primarily equities to a mix of stocks and bonds.
For young investors, “that can be an appropriate strategy for their age, especially if they aren’t comfortable setting up something a little more nuanced,” says Sheila Shaffer, a financial advisor at Janney Montgomery Scott in Washington, D.C.
Target-date funds’ fees are also falling, making them more attractive. The average asset-weighted fee for target-date funds fell to 0.34% in 2021, down from 0.37% in 2020 and 0.51% five years ago, according to a recent report from research firm Morningstar.
Shaffer suggests putting aside 10% of your income for retirement. “Once you meet your retirement savings [goals] and pay your bills, whatever funds you have, just systematically invest over time,” she says. “You’ll build a nice portfolio and have the kind of independence that kind of investing buys you.”
Beyond Basics
During volatile periods, investors with portfolios containing multiple securities may want to consider rebalancing them—taking profits in the rare holdings that are up and adding to beaten-down positions, says Douglas Boneparth, an advisor and owner of Bone Fide Wealth in New York.
They may also want to add to current positions by buying when prices are low.
“Dips like this can be buying opportunities for long-term investors,” Boneparth says. “It’s even more advantageous for younger investors because they have time on their side. They can let [the investments] compound.”
This year’s market slide may present tactical opportunities to rejigger portfolios, as well. Investors with concentrated positions—for example, shares of their employer’s stock— could sell some of those assets in order to better diversify their portfolio and avoid a bigger tax hit than they would have before markets tumbled, says Colin Overweg, a financial planner and founder of Advize Wealth. “When the market is down, it can be a good time to sell concentrated positions with lower capital gains and then diversify,” he says.
Investors can also use this moment to convert a traditional IRA to a Roth IRA. Roths allow you to contribute after-tax dollars, but you don’t pay taxes on withdrawals during retirement. That’s the opposite of a traditional IRA, which allows you to make pretax contributions and then pay taxes on withdrawals. A conversion triggers a tax hit, but given market declines, the consequences may be less severe, says Overweg, who is based in Los Angeles.
“This is not timing the market, but it is an opportunity for tax savings,” Overweg says.
For clients looking to earn more from the fixed-income part of their portfolio or from emergency funds, I bonds are an option and can be bought directly from the federal government via the TreasuryDirect.gov website. They earn interest based on combining a fixed rate and an inflation rate, but investors need to hold I bonds for a year and are limited to purchasing $10,000 worth of them each year. As of May 11, their rate is 9.62%.
“In December, when inflation started increasing, I had clients buy $10,000 worth and then another $10,000 in January,” Overweg says. “I don’t know where else you can find an emergency fund yielding 8%.”
Given sky-high real estate prices, people interested in buying a house may be tempted to use their short-term savings to boost the size of their down payments. But Kyle McBrien, a financial planner at robo-advisor Betterment, cautions that investors’ risk tolerance should be aligned with their goals and time horizon.
“Anything that is shorter term—anything you want to use in the next couple of years, probably shouldn’t be invested the same way as your retirement assets, which are 30 years out,” McBrien says.
An Investor’s Worst Enemy
While younger investors may have time on their side, they also need a plan—and one they can stick to, experts say. Jumping out of the market at the wrong time or trying to time the market can lead to damaging errors.
“If you miss the best day in the market in a year, it can have a big impact on your portfolio over the long term,” says Barry Gilbert, vice president of research at LPL Financial. “Sometimes the best day is right after one of the worst days.”
Market declines can mean cheaper valuations for stocks, and better opportunities for investors. Gilbert, who works on LPL’s long-term capital market assumption, says the firm’s 10-year outlook for market returns is up one to two percentage points from where it was a year ago.
But investors need to be able to stomach the volatility that can come with investing. “When you have volatility, that’s when you really learn what your risk tolerance is,” Gilbert says.
Betterment’s McBrien suggests that new investors who are reluctant to invest a big lump sum try to invest in increments. “You can dollar-cost average,” McBrien says. “Whether it’s once a week or once a month, you can put it a little in at a time, and you’re still investing in a structured way and taking the emotion out of it.”
Every financial planner interviewed for this article stressed this point: Don’t get caught up in the emotional roller coaster that can develop when you slavishly follow the market’s every up and down. An investor’s own worst enemy can be him or herself.
“The only time people get hurt on a roller coaster is when they jump off,” Overweg says.
This article was written by Andrew Welsch and published in Barron’s on May 11, 2022.
- https://www.barrons.com/advisor/articles/young-investors-stock-market-volatility-51652291327
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