Broke Millennial Takes on Investing

by Erin Lowry

  EXCHANGE-TRADED FUND (ETF): A hybrid option between mutual-fund investing and being able to buy and sell stocks. It makes sense to purchase this type of fund if you want to be able to trade instantly during the day, as you would with a stock. (Mutual fund transactions occur in bulk after the closing bell.) ETFs usually have pretty low expense ratios and lower minimums to buy in, making them attractive, but you also have to pay a commission to a broker each time you buy and sell. This could negate the advantage of a lower expense ratio.

  COMPOUND INTEREST (COMPOUNDING): Compound interest is why investing early and consistently are touted as the easiest ways to build wealth. In short, compound interest is earning interest on interest.

  Year 1: You invest $1,000 dollars in the Dogs Are Great index fund. The DAG fund earns an 8 percent return and you end the year with $1,080.

  Year 2: You earn interest on $1,080, not the initial $1,000 you invested. This year, DAG earns a 12 percent return and you have $1,209.60.

  If you’d just been earning 12 percent on the initial $1,000 investment instead of on the $1,080, then you would’ve earned $1,120. Combining year 1 returns of $80 with year 2 returns of $120 and simple interest (non-compounding interest) would’ve netted you $1,200 instead of compounding interest getting you $1,209.60.

  A difference of less than $10 sounds low, but that’s just in a year. Contextualize it over the span of decades and with more than $1,000. Compounding adds up, fast.

  DIVIDEND: A payment you get from the company or fund in which you invested for being a shareholder. Dividends are a result of company earnings and generally get paid on a quarterly basis (i.e., every three months). Not all companies offer dividends, and dividends can be paid in various forms, such as cash or shares of stock. You can set up your dividends to automatically be reinvested.

  DIVIDEND REINVESTMENT PLAN (DRIP): Instead of taking your cash dividend as a check or direct deposit into your bank account, you can use it to buy more shares. Usually, reinvesting your dividends comes without fees or commissions. That means you get a discount on your purchase because a fee doesn’t chip away at your returns. It also creates a passive way for you to keep building on your investments with no thought required after you’ve opted in. You can often opt in to a DRIP when setting up your brokerage account.

  THINGS WORTH KNOWING ONCE YOU GET STARTED

  FIDUCIARY: Under the fiduciary standard, the financial professional or organization is ethically obligated to act in your best interest. Therefore, it is generally wise to work with a fiduciary.

  SUITABILITY: Under the “suitability standard,” a financial professional or organization is obligated to do only what is suitable and not harmful to you. The suitability standard has the potential to create a conflict of interest because the financial professional could direct you to invest in or purchase a product that earns the professional a commission or higher fee as opposed to the product that is best for you.

  LOAD FUNDS: You pay a fee for the purchase (front-end load) or sale (back-end load) of your mutual fund investment. The fees for load funds usually pay the broker or advisor who researched the fund, advised you to purchase it, and placed the buy order for you. Back-end loads may be reduced or phased out, depending on how long you hold the fund. DIY investors typically avoid investing in load funds.

  NO-LOAD FUNDS: There is no fee to buy into or sell your investment in this type of mutual fund. The expense ratios on no-load funds are typically lower than that of their load-fund counterparts. The fewer and lower the fees, the more you, the investor, pocket.

  12B-1 FEE: Another fee your brokerage may charge for the operational cost of running a mutual fund. It is normally baked into the expense ratio, so you may not notice it at first, but it does push the overall cost up. The 12b-1 fee is capped at 1 percent by FINRA (Financial Industry Regulatory Authority).1 That may not sound like much, but a 1 percent fee can really eat away at your returns, so check to see if a fund comes with a 12b-1 fee before making the purchase.

  REBALANCING: Rebalancing is the process of buying and selling investments in your portfolio so the overall asset allocation is better aligned with your goals, time horizon, tax strategy, and risk tolerance. For example, let’s say you have $40,000 invested in 60 percent stocks and 40 percent bonds in accordance with your time horizon and risk tolerance. The stock market did really well for three years, so the $24,000 you had invested in the stocks grew to $33,000 while the $16,000 in bonds rose only to $17,000. Now your portfolio is around 66 percent stocks and 34 percent bonds. You’ll need to rebalance to get it back to 60/40. Generally, you want to rebalance at least once a year.

  BULL MARKET/BEAR MARKET: A bull market means investments are on an upswing and prices are rising, which often makes people want to buy. A bear market means prices on investments are falling and people may lose confidence and start to sell. It is crucial to remember you will experience both bull and bear markets as an investor. The true guarantee of the stock market is that it’s cyclical and will always go up and down, which is why setting your time horizon; having a balanced portfolio; and proceeding with your eye on a long-term, buy-and-hold mentality (i.e., don’t panic and sell, sell, sell when the market dips) is a solid strategy. We’ll dig into this more throughout the book.

  CORRECTION: A correction is the downward trend of an index (e.g., the Dow Jones Industrial Average or S&P 500) or particular stock or commodity (e.g., cryptocurrency). Usually, correction is used when the value has dropped 10 percent or more. A correction can be an indicator that the stock market is heading for a bear market or even a recession, which is usually what you hear speculated in the media, but it’s not a guarantee. From 2008 to 2018 there were six market corrections of 10 percent or more2 on the S&P 500 index. Five of those corrections occurred after the Great Recession ended in June 2009. Corrections can also be a way to prevent a bubble.

  BUBBLE: A bubble follows a simple pattern: A commodity becomes popular, and people get frenzied about buying in, thinking someone else will pay more for the item than they did. The price of the commodity hits a ceiling and people start selling, panic mode sets in, and the whole market around said commodity plummets. You probably even participated in a popular bubble from the 1990s . . . Beanie Babies!

  Bubbles have been around for centuries. The classic bubble story money nerds like to tell is that of tulip mania, which swept Holland in 1637. In short, the Dutch got so crazy for tulip bulbs that it created a scarcity and thus supply and demand drove the prices up and up. Folks dumped their life savings and traded land in order to stockpile bulbs. Ultimately, as with all bubbles, it burst. People started to sell their stockpiled bulbs to actually cash in on their investments, which led to more and more people selling, which made prices plummet, and then more people panicked and tried to sell, which triggered a crash.

  RECESSION: Millennials are no strangers to this term, considering that the Great Recession heavily impacted the career prospects and financial outlook of many in our generation. A recession is a period of more than a few months marked by negative economic growth and often manifests with slowed production and higher unemployment.

  CAPITAL GAIN: Capital gain is investment jargon for making a profit on your investment by selling it for more than you paid. That profit doesn’t occur until you actually sell your investment. Say you bought three shares of Broke Millennial stock for $2,500. In the first year, the investment went up from $2,500 to $3,200. But you don’t sell. You hold the investment until five years later and decide to sell those three shares, which are valued at $5,000. When you sell those shares, your capital gain would be $2,500. You can get taxed on capital gains, aptly called a “capital gains tax.”

  TAX-LOSS HARVESTING: “Investments that you hold can go up and down. That’s why we hold a number of different kinds of them and diversify them together. When they go down, the IRS has a bonus for you where you can save taxes by effectively taking a
deduction for the losses. So the way you take that deduction is that you have to sell the investment. The trick, though, is you still want to be invested, so when you sell the investment you also want to buy back [a similar investment] to make sure you keep your portfolio in shape. Tax-loss harvesting is just a fancy term of looking for losses and taking the deduction to save you taxes,” explains Alex Benke, CFP® and vice president of advice and investing at Betterment.

  DOLLAR-COST AVERAGING: An investing strategy where you consistently contribute to an investment, often monthly, which means you’re buying in at different price points, sometimes low, sometimes high. This can result in a lower average cost of your shares. Dollar-cost averaging also prevents you from trying to time the market and helps you ease in to investing. It’s a strategy you’d already be using if you’re investing into a 401(k) with each paycheck.

  RETIREMENT TERMS

  Are your eyes starting to glaze over a bit? There have been pages of terminology, so instead of dumping all the retirement talk into this chapter (and thus forcing you to flip back and forth), we’re going to get into those in chapter 4, where we discuss retirement investing.

  LET’S TALK ABOUT INVESTING THEORIES

  You are going to hear about investing theories as you progress along your path to investing. Even something as simple as opening an investment app or checking out a robo-advisor will introduce you to terms like modern portfolio theory or Monte Carlo simulation. This begs the question: do I need to understand investment theories in order to start?

  “No, complete waste of time,” says Jill Schlesinger, CFP®, CBS News business analyst and author of The Dumb Things Smart People Do with Their Money.

  I agree with Schlesinger, and in fact, we aren’t going to talk about investing theories. There are entire books dedicated to specific investing theories, so we’re not going to fall down that rabbit hole.

  Instead, it’s time to move on from learning a “foreign language” of investing to learning how to grab that bull by the horns—especially when risk, for you, is a four-letter word.

  Chapter 3

  Grabbing the Bull by the Horns When You’re Risk Averse

  “THEN I LOGGED ON and saw all the balances showed red numbers!” my friend Hazel bemoaned as we walked around our neighborhood park.

  Hazel had started investing only about six weeks prior to our conversation. Despite taking quite a bit of risk in her career, which paid off, she self-identified as a risk-averse person when it came to her money. Hazel rationally understood why she should have some of her money in the market, but battled knee-jerk reactions to take her money out when those obnoxious, red, downward-pointing arrows showed up next to her investments.

  I knew all this, which is why I responded by saying, “I texted you not to check your investments today. We’re going through a market correction, so your investments were bound to take a tumble, but it’ll be okay.”

  “Yeah, but I can’t log in to my bank account without also seeing my investments,” she shot back.

  “Oh, yeah, that’s a bit problematic,” I acknowledged with a wry chuckle. “Are the investments at the top of the screen or the bottom when you log in?”

  “Top,” she said.

  “Okay, I know this sounds silly, but what if you just cover your investment information with a sheet of paper or your hand when you log in to do your regular banking? That way, you aren’t checking in on your investments, essentially against your will, on a weekly basis.”

  The recommendation sounds silly, but sometimes we have to set up this kind of barrier to protect our portfolios from ourselves. Frankly, you can be the biggest danger to your portfolio, especially if you have a low tolerance for risk.

  The biggest issue with investing for both novice and seasoned investors is handling their emotions during market fluctuations. It’s particularly difficult for risk-averse people to start investing at all and then leave well enough alone when the market starts to tumble. But it’s important you learn how to grab the bull by the horns and avoid letting the bear intimidate you. Stock market puns!

  YES, YOUR INVESTMENTS WILL GO DOWN AT SOME POINT

  Remember in shows like Fear Factor how contestants underwent a perverse version of immersion therapy by completing awful tasks like being in a tank with snakes? While not as extreme, investing isn’t completely dissimilar. You have to face your fear of losing money.

  “The bottom line is the stock market does go up and down. That’s just the nature of the stock market,” says Carrie Schwab-Pomerantz, president of Charles Schwab Foundation, and senior vice president of Charles Schwab & Co., Inc. “But over the long term, it outperforms bonds and cash.”

  Of course, knowing this doesn’t exactly keep you from having an emotional reaction.

  “It’s easy, when the markets are down, to get emotional about it and start pulling dollars out of the market when it’s going down and putting dollars back in the market as it’s rising,” says Julie Virta, senior financial advisor with Vanguard Personal Advisor Services®.

  The particular problem for many Millennials is that we grew up during the Great Recession. Kelly Lannan, director at Fidelity Investments, graduated from college in 2008, directly into the market downturn. “It was very scary seeing that, so as a result, I think we’re naturally risk averse,” acknowledges Lannan. “I think that Millennials are good savers, however, making that transition from taking something in your bank account that you can see every day, that’s very safe, it’s federally protected, and then putting it into an investment vehicle where there’s much uncertainty, well, it can be hard to understand.”

  While the Great Recession may have caused some of the anxiety, it also provided a valuable lesson.

  “The market was at an all-time high in 2007. When I say ‘the market,’ I mean the S&P 500 as a benchmark,” says Schwab-Pomerantz. “Then, in 2008, it crashed 50 percent. So, if you had 1,000 bucks, all of a sudden it’s $500 if it’s in the S&P 500. But guess what? Not only has the stock market surpassed the 2008 number but also the 2007 number.”

  This real-life example demonstrates the importance of a buy-and-hold, long-term strategy when it comes to your investments. Had you been invested in the S&P 500 in 2008 when it dropped, and then sold, you would’ve not only lost $500 by selling, but also lost out on the gains of the market that rebounded and surpassed a previous all-time high.

  HERE’S AN IMPORTANT SECRET TO KNOW

  One of my professors liked to share a story about her neighbor. Her neighbor knew she worked in finance and liked to make small talk in the elevator by saying, “Guess how much I made on x, y, z stock yesterday?” My professor would always respond with the same line: “Oh, did you sell?”

  The point of her story is that you haven’t actually made a profit until you sell your investment and the money becomes liquid. The same is true on the other side of that scenario, when the stock market is taking a tumble.

  “Hopefully, you won’t panic and sell, because guess what? You’re going to lock in your losses,” says Schwab-Pomerantz.

  This is why you’ll hear both in this book and from many other investors that the buy-and-hold strategy is important. You should be playing the long game here, so if your portfolio drops because the market is going through a correction, or worse, a recession, then you haven’t actually lost the money until you sell. And if you sell you have no opportunity to gain it back when the market goes back up.

  WHY ASSET ALLOCATION AND DIVERSIFICATION ARE YOUR BESTIES

  It’s understandable if you feel like my friend Hazel. Investing in the stock market can be intimidating, not just because you don’t totally understand how it works (yet), but because you don’t want to lose money. That’s where two important investing strategies come into play.

  I asked many experts which terms they thought every rookie investor should know, and almost every single one said asset allocation and diversif
ication. The reason these two terms are so critical is because understanding them and, more important, putting them into play will help mitigate the risk you take by investing your money in the stock market.

  It’s certainly not just rookies who use these strategies.

  “[Asset allocation and diversification] are the investing strategies used by the largest pensions and funds in the United States,” says Schwab-Pomerantz. “This whole notion of a well-diversified portfolio and using proper asset allocation of stocks, bonds, and cash—that’s how the most successful investors have achieved their success.”

  Diversification is pretty simple to understand. You don’t want to “put all your eggs in one basket.” You don’t want to invest in a single asset class—for example, don’t leave all your money in cash or just in stocks or exclusively in bonds or only own real estate. Then you want to also diversify within an asset class—for example, don’t invest only in a single company’s stock.

  The use of asset allocation is twofold, according to Jill Schlesinger, CFP®, CBS News business analyst and author of The Dumb Things Smart People Do with Their Money. “Over the long term, what you’re hoping for is that different asset classes act in different ways over different periods of time. But, essentially, it’s like hoping to protect you from yourself, because if you have 100 percent of your money in stocks, and the stock market drops by 20 percent, your $1,000 is $800. That might freak someone out. But if the stock market goes down by 20 percent, and only half of your money is in stocks, then if your $1,000 went to $900, it may feel more bearable. So, asset allocation is something that can really help people. What it also does is limit your upside sometimes, when the market is running away, but you have to be willing to make that deal with the devil. I’m willing to forgo some of my upside because the downside scares the shit out of me.”