Why Young Investors Often Misstep
Investing can be intimidating for those just starting out. A recent Bankrate poll found that 21% of Americans shy away from stocks because the market feels too daunting. This apprehension is even higher among younger generations, with 29% of Gen Z and 24% of millennials expressing discomfort with stock investing. However, financial advisors warn that avoiding stocks in favor of cash or bonds may be a critical error for young investors seeking long-term wealth.
The Biggest Mistake: Prioritizing Downside Over Upside
“When you’re young, worrying more about downside than upside is probably the biggest mistake,” said Josh Brown, CEO of Ritholtz Wealth Management. “You have to get rich before you focus on preserving your wealth.”
Brown asserts that young investors should avoid holding significant cash or bonds within their investment portfolios. Instead, they should be fully invested in the stock market to maximize growth potential.
Young Investors Have Time on Their Side
While stocks are typically more volatile than cash or bonds, their long-term performance historically surpasses these safer assets. This advantage is crucial for young investors who have decades for their investments to grow and recover from market fluctuations. Data from finance professor Aswath Damodaran at New York University shows the S&P 500 has delivered an average annual return of nearly 12%, including dividends, from 1928 through 2024. In contrast, 10-year U.S. Treasury bonds and corporate bonds returned approximately 5% and 7% annually, respectively. Brown emphasizes the unique benefit of time for young investors: “When you’re a young investor, you have something at your disposal that every professional investor dreams that they can have, which is more time. When you appreciate how much time you have, you recognize the benefit of long-term compounding. Even though you think you’re taking more risk by buying and holding [stocks], you’re actually taking less risk.”
Effective Strategies: Buy and Hold Through Index Funds
Simply buying stocks is not enough; how investors hold them matters significantly. For beginners, owning a broad market index fund is typically a safer and more effective approach than selecting individual stocks. Index mutual funds and exchange-traded funds (ETFs) provide diversification by holding hundreds of stocks that collectively track the broad market. Historically, these funds have outperformed most individual stock pickers over extended periods and reduce the complexity of investing.
“If you’re going to be self-directed and you’re going to do it yourself, I would utilize index [mutual] funds and index ETFs,” Brown advises. “And until you’ve got six figures of pure stock market exposure at a low cost, there’s really nothing else worth talking about.”
Christine Benz, director of personal finance and retirement planning at Morningstar, recommends total market index funds like the Vanguard Total World Stock ETF (VT) as a “one-and-done fund” for young investors. Balanced or target-date funds are also viable options. The latter gradually reduce stock exposure as investors approach retirement age.
Choosing the Right Investment Accounts
Advisors stress the importance of selecting appropriate accounts for holding investments. Tax-advantaged retirement accounts such as 401(k)s or IRAs are often better suited for funds like target-date funds to avoid unexpected tax liabilities compared to taxable brokerage accounts.
FinOracleAI — Market View
Young investors face a critical decision: prioritize short-term safety or embrace long-term growth through stocks. Josh Brown’s guidance aligns with historical data underscoring the superior returns of equities and the power of compounding over time.
- Opportunities: Harnessing decades of compounding via stock market investments can substantially grow wealth.
- Risks: Market volatility can lead to short-term losses, but these are mitigated by a long investment horizon.
- Strategy: Utilizing diversified, low-cost index funds minimizes risk and complexity for novice investors.
- Account Selection: Leveraging tax-advantaged accounts optimizes after-tax returns and reduces unexpected tax burdens.
Impact: Encouraging young investors to fully engage with the stock market early enhances their potential for wealth accumulation and financial security over the long term.
