New investors beware: The easy money you made in the stock market probably won’t continue
The past year or so has been one of the oddest periods ever for the stock market and economy, with a rare pandemic shutting down businesses and throwing millions of people out of work.
At the same time, the federal government stepped up with unprecedented amounts of stimulus payments, free loans to businesses, eviction moratoriums and other aid — even a delayed deadline for filing income-tax returns.
Things are off-the-charts unusual. Yet for novice investors who stuck a toe in the stock market for the first time over the past year or so, it’s all they know.
And it’s not just a few people, either. Armed with stimulus checks and motivated by boredom perhaps, millions of people took the stock market plunge last year — a whopping 15% of all current stock investors got their start in 2020, according to a new Schwab survey.
Most must be thinking, “This is easy.” Here are some reasons why they should think twice.
Don’t expect the next down cycle to be so kind.
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The stock market has climbed steadily for the past 13 months, over which time it has nearly doubled in value. That’s rare in itself. But the really unusual part was the extremely short duration of the preceding bear market or downward spiral, which lasted just five weeks.
No wonder these first-year investors are more optimistic about near- and long-term results compared to more seasoned market participants, according to the Schwab survey. The newbies also tend to be younger — 35 years old, on average, compared to 48 for people who started investing prior to 2020. They thus can afford to be more optimistic, as they have more time to make up losses.
It’s true that rising or bull markets always spring from the ashes of bear markets, but usually those preceding downdrafts are much more prolonged. That’s the real challenge of investing — dealing with month after month, if not year after year, of falling prices, when disappointment leads to despair and then desperation.
If you blinked, you missed the bearish phase of 2020. The next downward cycle won’t be so kind.
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Don’t count on so much free money
Investing, like gambling, isn’t so difficult when you’re playing with house money. That was somewhat the case for millions of Americans who received stimulus payments from Uncle Sam or possibly souped-up unemployment benefits.
Sure, plenty of people used this cash as financial lifelines, to stay afloat. But others saved their stimulus checks or put them to use in the stock market.
In other words, some new investors probably don’t fully appreciate that investing involves sacrifice: You forego consumption today in hopes that your money will grow enough over time that higher spending will be possible years down the road.
Stimulus checks don’t arrive every year, though there is one form of free money that you can tap into on an ongoing basis. These are the matching funds available through workplace 401(k)-style funds that employers ante up to encourage workers to invest.
Even the federal government offers limited retired matching funds to lower-income workers, through the widely underappreciated Retirement Savers tax credit (details at irs.gov). It’s not a huge sum — a maximum credit of $1,000 annually to the lowest-income workers — but it beats the stimulus money you can count on most years.
Don’t assume your buddies are right
There’s a lot of psychology to investing, and one tendency is that people seek out confirming views from friends, family members and colleagues. There’s something heartening about having your investing ideas validated by others. The danger is that these other parties might have even less knowledge than you.
More than in most years, collaborative investing appears to be on the rise. For example, a survey by MagnifyMoney, a subsidiary of Lending Tree, found that nearly six in 10 investors age 40 or younger are members of online forums such as Reddit. These can be good ways to learn about finances, but they also might lead you astray.
“It’s great that these communities are introducing a lot of people to investing, which is one of the best ways to build wealth over a lifetime,” said Tendayi Kapfidze, LendingTree’s chief economist, in a statement. “A concern is that some are leading to relatively short-term trading concentrated in a few stocks with hopes of getting rich quick.”
Usually, investors are better off thinking for themselves and tuning out the “noise” or outside distractions. In part, this is because other people often have different goals, tolerance for risk or other motivations compared to you. Or, they’re just wrong.
Don’t neglect your financial foundation
Stock market investing is important — and one of the best ways to build long-term wealth. But it shouldn’t come at the expense of other financial needs.
Setting up a rainy day fund is one example. It seems simple enough — accumulate money in a savings account to meet emergency car or appliance repairs or to tide you over if you lose your job. Yet many Americans have no personal safety nets — 43% of respondents in a recent study by Clever Real Estate said they have nothing.
Dana Sandoval, a certified financial planner at TCI Wealth Advisors in Denver who educates young adults in the nonprofit 3rd Decade program, suggests that everyone set up an emergency fund and take other fundamental steps. These include participating in workplace 401(k) plans if available and gravitating toward Roth Individual Retirement Accounts, which allow for tax-free withdrawals down the road.
Understanding the tax implications is important, as stock market profits might be taxed as ordinary income, at lower capital-gain rates or as untaxed withdrawals, depending on the type of account and how long you own an investment.
And rather than concentrate your money in a handful of stocks, Sandoval recommends spreading it out through low-cost, diversified mutual funds or exchange-traded funds. The market’s strong performance last year, she noted, was driven by a smattering of large, technology-focused companies including Facebook, Amazon, Apple, Netflix and Google.
But already, there are signs that the market’s leadership is shifting.
Besides, pinpointing future hot stocks isn’t easy to do, except in hindsight.
“Saving more and controlling expenses will have a more predictable positive impact,” she said.
Reach the reporter at [email protected].
This article originally appeared on Arizona Republic: Stock market: New investors should know what’s next for stocks
