Investing Early: A Key to Financial Growth
One timeless saying holds true: the money you save and invest in your youth has the potential to grow exponentially, much like a snowball gaining momentum as it rolls downhill. But how does one begin the journey of investing this money?
In a 2020 interview with NPR’s Chris Arnold, the late investor and endowment fund manager David Swensen emphasized the importance of grasping the fundamental dynamics of the investment landscape as the initial step. Swensen, renowned for overseeing Yale’s multi-billion dollar endowment with unparalleled returns, authored Unconventional Success: A Fundamental Approach to Personal Investment, offering insights on how individual investors can effectively manage their financial assets.
Swensen, alongside behavioral economist Brigitte Madrian from Brigham Young University, shared valuable insights with NPR on crafting a well-diversified portfolio that can yield significant returns in the future.
1. Avoid selling stocks during market downturns
### Understanding Stock Market Investment Tips
When the stock market experiences a downturn, it can be quite daunting. Witnessing a decline in your retirement savings can be unsettling. Consider this scenario as akin to riding a roller coaster. Roller coasters can induce fear as well, but the key is to stay seated and ride it out. Similarly, it’s advisable to remain invested and wait for the market to bounce back.
Attempting to time the market by selling during a crisis is risky. Predicting when the market will rebound is nearly impossible. If you hastily sell off your investments, you risk being left with a diminished retirement fund at the market’s nadir, missing out on potential gains when the market eventually recovers.
According to Swensen, selling during a crisis may lead to irreversible damage to your portfolio. Madrian highlights the psychological aspect of financial losses, stating that the pain of losing money is significantly more intense than the joy of gaining an equivalent amount. Despite the urge to alleviate this distress by selling stocks, it is often an ill-advised decision.
To avoid succumbing to impulsive decisions driven by emotions, it is crucial to resist immediate reactions and engage in rational thinking. Madrian, an expert in behavioral finance, emphasizes the importance of not making financial decisions when emotions are running high. Emotional extremes, whether excitement or fear, are indicators that it may not be the optimal time to make financial choices.
In essence, exercising restraint during turbulent market conditions and refraining from emotional decision-making are fundamental principles that apply not only to investing but also to life in general.
2. Update your investment portfolio annually for better stock market performance
**Rebalancing Your Investment Portfolio During a Stock Market Crash**
Optimizing Your Investments
During a stock market crash, it’s natural to feel compelled to take action. According to Swensen, one effective strategy is rebalancing your portfolio: selling assets that have increased in value and purchasing those that have decreased. This approach holds significant power in stabilizing your investments.
Utilizing a Well-Designed Investment Strategy
Imagine you had a meticulously planned investment portfolio represented by a pie chart before the market downturn. In this scenario, a market crash presents an opportunity for rebalancing. For instance, if stocks plummet in value while treasury bonds surge due to increased demand for safer investments, the proportion of your portfolio allocated to stocks decreases while that of bonds increases.
To realign your portfolio, you would sell a portion of your treasury bonds and acquire more stocks. This strategic move adheres to your initial investment plan of buying low and selling high, ensuring your investment pie chart is restored to equilibrium. Swensen recommends investing in the entire U.S. stock market through low-cost index funds for optimal results.
The Basics of Rebalancing
Consider rebalancing as a fundamental principle in investing: buy low, sell high. Swensen emphasizes that this method is a reliable approach to generate profits, and it doesn’t require frequent adjustments.
“It’s advisable to review your portfolio at least annually and especially after significant market fluctuations to ensure it aligns with your objectives,” Swensen advises.
For individuals enrolled in retirement savings plans like a 401k offered by their employer, Madrian suggests that some plans feature automatic rebalancing capabilities, enabling investors to realign their portfolios once or twice a year effortlessly.
3. Avoid selecting individual stocks
Stock Market Investment Tips: Why Individual Stock Picking Might Not Be the Best Strategy
Investing in the stock market is a logical choice due to historically higher returns compared to bonds or other investments. However, focusing on individual stocks, such as popular companies like Amazon or Tesla, may not be the wisest approach.
Here’s a revealing truth about Wall Street: even seasoned professionals struggle to select individual companies that will outperform the overall market. Research shows that 80 to 90% of mutual fund managers fall short in this endeavor over time.
Believing that reading investing magazines or watching financial shows can help you pick winning stocks is, as Swensen puts it, “essentially a futile pursuit.”
Considering that professionals dedicated to beating the market find it challenging to do so consistently, it’s unrealistic to think that casual investors can compete by spending minimal time on weekends analyzing stocks.
Given these challenges, what is the most effective way to approach stock ownership?
4. Opt for index funds over actively managed funds and be mindful of excessive fees
Stock Market Investment Tips: Embrace Index Funds for Better Returns
Swensen recommends investing in a slice of the entire stock market through low-cost, broad-based index funds. An excellent example is the Vanguard Total Stock Market Index Fund, which provides exposure to nearly every U.S. public company at a minimal annual fee of just 0.14%.
Unlike actively managed mutual funds that often charge fees significantly higher than index funds, index funds operate passively. They simply track a predetermined list of stocks without attempting to select individual winners or losers.
Actively managed funds involve paying professional investors to curate a portfolio of stocks that are expected to outperform the market. However, as mentioned earlier, the majority of these funds fail to surpass the market returns once their fees are considered.
Swensen emphasizes that based on historical data, opting for an index fund strategy has consistently been the superior choice for investors. It typically leads to better outcomes compared to actively managed alternatives.
Another type of passively managed fund similar to index funds is Exchange-Traded Funds (ETFs). However, Swensen advises against overly specialized ETFs or index funds. It’s crucial to maintain a diversified approach in your investment strategy.
5. Strategies for Stock Market Investment Success
When it comes to stock market investment tips, diversifying your portfolio is crucial. Renowned investor David Swensen recommends a well-rounded portfolio allocation that includes:
- 30% in U.S. stocks.
- 15% in developed country stocks.
- 5% in emerging market stocks.
- 20% in domestic U.S. real estate.
- 15% in U.S. Treasury bonds.
- 15% in U.S. Treasury Inflation Protected Securities.
For those looking to make significant changes to their portfolio, timing is key. It’s advisable not to make drastic moves immediately after a stock market crash. Consider employing the strategy of “dollar cost averaging,” where gradual adjustments are made over an extended period to reach your desired allocation.
As individuals near retirement or enter this phase, the investment landscape becomes more intricate. Seeking guidance from a financial advisor is often recommended by experts to navigate this stage effectively.
Notable for its nonprofit structure, Vanguard operates with a focus on customer benefit. While David Swensen refrains from endorsing specific financial institutions, he acknowledges Vanguard’s unique low-cost and nonprofit approach.
Founded by Jack Bogle with a commitment to providing index funds and unbiased advice, Vanguard stands out in the financial industry. Swensen emphasizes the importance of individuals being aware of such ethical practices.
Expressing a wish for more nonprofit entities dedicated to investor welfare, Swensen highlights the scarcity of such organizations in the financial sector.
For those seeking reliable financial guidance, experts also recommend exploring The National Association of Personal Financial Advisors (NAPFA). Known for its “fee-only” advisors, NAPFA ensures that advisors are compensated solely by clients, eliminating potential conflicts of interest. This stands in contrast to advisors who may receive commissions for directing clients towards high-fee investments like actively managed mutual funds.
If you have any questions or feedback, feel free to reach out by leaving a voicemail at 202-216-9823 or emailing us at [email protected].
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The audio segment of this article was created by Chloee Weiner. This piece was originally published on Dec. 15, 2018. You can listen to the original audio recording here.
