- Personal Finance
Should I Invest in the Stock Market - Does It Help People Save Money
Should I Invest in the Stock Market
"I'm afraid to invest in the Market", "I don't want to lose all my money", "People only lose in the market". In my 7 years as a Financial Consultant I hear these comments and many more just like them every day. With the market as volatile as it is today, people are afraid to put their money at risk. Are some of these comments true, will people lose all their money in the market? Do people only lose in the market? The answer to the questions is an emphatic yes and no. Alot of people are afraid of the market, some people will lose money in the market and some people will in the market. So the next question becomes, how do I make money in the market and not lose what I have? The answer to that question is diversification and time.
History of the Market
Let's start with a little background of the market and people in general. The market was started in a coffee shop in the 1780’s with approximately 20 companies. It closed around $20.00, a lot of money back then. Since then it has gone up from there. Since the stock market crash of 1929, there has been a lot of legislation that came out to protect the consumer and regulated how investments were handled. Looking at every 10 year cycle since the 1930's the market has shown a average yearly growth of 10.4%. Personally, I think that is pretty good, considering you won't see that in a CD. The market crash of October 1987, the market closed at just under 2000. In September 2001, it was at 11000 and eventually dropped to approximately 7500 over the next two years. Since 1987 that is still a 275% increase. A bull market began in 2003 and grew to 12000. Since 1987 that is a 500% return and since 2001, prior to the market fall, it shows a 9% increase. So history shows, the market has increased, not necessarily each year, but in time.
A Lesson in Human Nature
Now lets look at people, the common investor like you and me. In general most people just don’t understand the market, and if they don't understand something they are afraid it. This is human nature. People will usually remember the bad things and not the good things. For example, most people will say the market is always down, in reality it has had more up years than down years, how else could it average a 10.4% average yearly increase. I have met with people in the past couple of months, worried, complaining, and scared because their investments went down. Did they go down, yes they did. I have also had to remind some clients that in comparison to their original investment they are still up from where they started. I met with a client that invested a total of $1800.00 and the investment was at $2300 after two years, which is a 27% increase over the last two years, averaging 13% each year. The problem was 2 months ago it was at $24500. My question to my client was, "do you think you could have done better in a savings account or CD?" The answer I was given was "NO". So why did my client complain, get scared, and want to get out of the market? He was afraid because he did not remember that for 2 years the market went up. In fact, he was quite pleased in those 2 years.
My mother is the perfect example for this. I invested her money when the market reopened after September 11, 2001. Regardless to common belief, not everyone lost money from 2001 - 2002. In fact my mother saw a 5.6% increase in her accounts. This was due to diversification and including more conservative investments, like bonds. When stocks go down, bonds go up and vice versa. As the market began to improve in 2003, I began to shift her money into more equity based investments. Again, I began moving more to bonds during the beginning of the recession, to stabilize her accounts. She was happy when she saw a 15% increase last year, but now it dropped $4000 and she started to get scared. $4000 to her portfolio was only 4%. I had to remind her that since investing her money in 2001, she had averaged 9.6% every year, and that she was up over $60,000 in her account, and that she had withdrawn over $15000 in that time. So in 7 years she made over $75000. She admitted she was still in better shape than she was 7 years ago. Putting this in perspective calmed her fears.
Questions You Need to Answer
Not to paint a completely rosy picture, her scenario is one in which she did not need the money right away. She had time on her side, she did not need the money for at least 10 years. Investing in the market was good for her, but is it good for you? Before you can answer that question you must answer a couple more.
First, how much time do you have until you need to use, or expect to use the money? If you answer 3 years or less, the market is not for you. If you answer 3 - 7 years, you should be sitting down with a consultant, the market may be ok. If you answer over 7 - 10 years, the market is a good choice, 10 years or more, you're a fool not to invest in the market. If you have the time, the market will perform for you. Looking back on the history of the market, you will notice that with every downturn in the market, there is usually a double digit increase the following year. Also, you will not see a market down turn that lasts multiple years very often. The downturn from 2001 - 2003 was the longest period of a bear market in nearly 40 years.
Second, what is the money for and what else do you have? I have never told anyone to put all their money in the market or in market based investments. I expect and want to see a portion of their money in liquid or easily liquid form. Everyone should have an emergency fund of at least 3-6 months of living expenses. For my retired clients I would prefer to see at least $10,000 - $20,000 immediately available, sometimes higher depending on other assets and their comfort level. I do feel keeping over $50,000 is a bit excessive, that is a personal feeling though, it does depend on the client. I have recommended to some clients that they have $100,000 or more on hand.
Are CD's The Way To Go
If the money is all the money they have in the world, they should not be too aggressive with the money. Do I think CD's are the way to go, not necessarily. CD's have their place, but let’s look at CD's. They are safe and will never lose money, as long as the CD is not redeemed early. The days of getting over 10% on a CD is gone. Ahhh, the 80's, I miss them too. At that time interest rates on loans were 20% and higher. As of this writing 1 year CD's are around .65%. Inflation at a conservative level is at 3.5% and lets not forget taxes. Without even looking at taxes the average CD buyer is already losing money. Yes it may be worth more than what you started with, but it buys less than too. An example of this, my first new car in 1990 was $7,000.00. In 2000 that same car had a base price of $14,000.00, that's a 7.2% yearly increase. Where do CD's fit in? They are a short term investment vehicle. If you have a plan to use the money within the next 24 - 36 months, CD's are the way to go.
There are so many other fixed investments and less volatile products that has a higher rate of return than a CD. Bonds and Fixed Annuities for example....I know, Annuties such a bad word, that is another topic all together. Let me just say, I like annuities. Back to our question is the stock market a good place to invest. Emphatically yes it is. Yes. Yes. Yes. The market on average has returned over 10% in every 10 year period. That's doubling your money every 7 years or so. The market it does go down, but take a look at history, when it goes down, it comes back up. Very often, more than it went down. If it didn't, the Dow would not be over 12000. Remember in October 1987, it was around 1900. So it goes up, and if it has that track record, why would you not invest in it.
How do people consistently lose in the market? That's easy. The market is a cycle, much like a circle. When it is at the bottom, to get to the top it has to go up. The common investor will see it go up and watch it. They hear all their friends talking about investing and the luck they are having, but our investor waits. After some time of watching and talking he decides to get in, thinking that the market will never go down, our investor began investing near the top of the circle. The market passes the top of the circle and begins to go down the other side. Our investor is nervous and figures it will come up, but after waiting and seeing his account go down, he decides to cut his losses. Guess where, near the bottom of the circle, so he just bought high and sold low. Soon, the market begins to go past the bottom and heads back up. If our investor would have waited and not panicked he would have seen the market go back up. There is no such thing as timing the market; you just have to be patient.
When you're younger, invest more aggressively, become more conservative as you get older. At retirement look at bonds. They are not very volatile and is interest based, thus preserving your capital, at normally better rates than a 3% CD. How about a 4% fixed annuity that is tax deferred, that's even better, if you are not using the money. Take a look around, the ones with the money all invested, the ones that are penny pinching are in the CD's. One last piece of advice, don't play the market by yourself, unless you have the time to learn about it. Sit down with a Financial Consultant and put a plan together. Let them know your goals and they will help you meet them. Happy Investing.