Avoid risky "stonks" by answering a basic investing question

When I’m not writing Strategy newsletters, I race bicycles. This hobby has helped me learn one thing: As much as I love to win, I really hate to lose. As I’ve been interviewing experts for this month-long series on investing, I’ve been thinking about that feeling a lot.

Because when it comes to investing their hard-earned money, many people feel the same way about losing — they would rather avoid it.

Financial news headlines claim that millennials, some of whom grew up during the 2008 recession, are spooked by investing. Quoting Gallup poll stats, the LA Times reported that 49 percent of millennials held stocks. By comparison, in 2001 through 2008, about 61 percent of Americans aged 23 to 38 held stocks. As markets soared this year, that means half of millennials were left out.

A version of this article first appeared as the Strategy newsletter. Sign up for free to receive it weekly.

With student debt and memories of the 2008 recession still fresh (even in the new decade), investing can seem imprudent if not impossible. Redditor yes_its_him, a contributor to r/personalfinance’s wiki subreddit, tells Inverse that, occasionally, he has also seen this fear of losing can stop people from getting the most out of the investment options available to them.

“A lot of people have heard different things, or they’re kind of biased against rich people, or whatever. They assume that this sort of thing is for someone else, and that if they try it, they’re just going to get burned,” u/_yes_its_him says. “That’s all a big mistake.”

This newsletter is about getting your feet wet with investing, but with a very specific purpose of minimizing the risk as much as you can.

That means that there won’t be any pie in the sky payoff from applying this strategy, but, if you’re a younger investor with time on your side, these are some basic things to consider. Also, keep in mind this is the second part in our month-long finance series. If you’d like to learn how to do a full financial checkup before diving in, you can find that newsletter here.

I’m Emma Betuel, a staff writer at Inverse, and this is Strategy, a newsletter packed with actionable tips to help you manage your career, life, and finances. If you know someone who might be into this newsletter, you can pass it to them using the link at the bottom of this email.

Why we’re not talking about picking stonks

When we talk about investing, it’s impossible not to talk a little bit about stonks.

The chaotic 2019 internet landscape warned us of dangers like 30-50 feral hogs while Cats also gave us the beautiful stonks meme. (Stonks is short for stocks.) Stonks and its intentional misspelling is designed to display the fraught nature of trying to hit it big while picking them.

The temptation to buy cheap stock in a company that you hope will become the next Tesla can feel tempting. Because this newsletter is largely about minimizing risk, there are safer courses of action than tethering your financial future to something like the Cybertruck’s unbreakable windows — if they break, you may see your savings go along with it.

That safer option is the low-cost index fund. At the risk of oversimplifying, those allow you to buy a piece of the market itself. That means that the fund essentially buys pieces of all the companies (or a representative sample) that are part of a third-party index, like the S&P 500. As u/yes_its_him puts it, “As [those companies] succeed, so do you.”

“That is one thing that I’m pretty consistently the advocate of on the site,” he says.

“You’re not willing to be riding the next rocket ship to outer space in terms of getting lucky, or picking the next Netflix or Chipotle. But conversely, you’re also not going to be seeing all your eggs in one basket crash and burn, like when Enron went out of business.”

Conventional estimates have suggested these funds roughly return about six to seven percent (that adds up over the course of decades). However, you’re also absolutely going to lose some money if there is a downturn. Because you’ve bought the market, there’s no way to beat it. Some years you may lose a lot of money if there’s a downturn.

But the idea is that if you’re a young investor, you can weather the storm and capitalize on an upward trend in the US economy that spans from the early 20th century to today. (Take a look at page 17 of this report to get an overall view.)

"It’s not as clear the US will be as dominant on the scene 2099 as it was in 1999."

That said, some researchers are advising a bit less blind faith when it comes to this kind of “buy and hold” strategy. As Edward McQuarrie, a professor emeritus at Santa Clara University, previously told Inverse, this strategy is informed by a period of history where the US won two world wars, became a financial leader, and “screwed the world like a colossus in the 50 years thereafter.”

“That basic research that fuels every bit of financial advice you ever read is confined to a period where the US was so successful,” McQuarrie continued. “How confident can we be about generalizing to the 21st century? It’s not as clear the US will be as dominant on the scene 2099 as it was in 1999.”

Additionally, there are suggestions that index funds may be getting too big for their own good. For a rundown of that emerging idea, take a look at this op-ed by founder of the Vanguard Group and father of the index fund John Bogle in the Wall Street Journal. Bloomberg has also published a deep-dive into the increasingly large sway that index funds have on our financial well-being.

That said, when I asked Abed Rabbani, an assistant professor of personal financial planning at the University of Missouri, for some advice, he said he still particularly likes low-cost index funds for younger investors.

“For investment in this age group, it’s important to invest in the low-cost index fund. That’s the best way to get into the investment world, get some experience. You don’t have to think about whether each company is good or bad,” he says.”

What to look for in an index fund

Where things can get tricky for new investors, though, is sorting through all those different index funds.

To pick the right one for you, Rabbani suggests that you consider a few things:

What are your goals for this money? If you’re looking to use this money for something essential in the next few years, it’s best not to put any risk on it. It may actually be better off in savings

If you have decided to go the low-cost index fund route, you’re in it for the long haul. In the short run, you may lose money, but in the long run, you’re hoping history is on your side.

To add to that, you need to consider how much risk you’re willing to tolerate. As the market fluctuates, whatever purpose you’ve decided to dedicate that money too hangs in the balance. Know how much you’re willing to gamble with that.

If you are willing to place some risk on things, Rabbani says the next step is to do a little research.

Rabbani explains that one way you can learn to sort through index funds is to compare the breadth of each one. “Broad means whether it’s capturing the whole market or whether it’s just a segment of the market,” he says. “You want the broadest index possible.”

Finally, learn a little bit about at least some of the companies in the fund. Find out what challenges, from climate change to foreign policy, might impact them. If you buy in, those things will affect you, too.

“Understand and research what you are getting into. I strongly advise against jumping into investment without knowing anything,” Rabbani says.

Minimizing risk: one potential tactic

Once you’ve selected your index fund, Rabbani has one final recommendation: Don’t jump in all at once! Rather, you may want to consider spreading out your investment. That’s a technique called dollar cost averaging.

That means that instead of taking the lump sum and buying into one fund right away, break it up into smaller portions and invest each month (or on another schedule) instead of putting it in all at once.

“That means you’re avoiding some of the impact of volatility over the years,” says Rabbani.

A version of this article first appeared as the Strategy newsletter. Sign up for free to receive it weekly.