Consider at the end of the third quarter that year-to-date emerging market equities are up 27.8%, U.S. large cap stocks are up 14.2%, non-U.S. equities are up 20.0% and so on and so on. This is impressive historical performance! If we could bottle up this exuberance and port it to other years I think many would take it. Can it continue? What will drive performance going forward? What unexpected shocks might cause substantial bumps (e.g. Trump, North Korea, terrorism, etc.)? You get the point, we can’t predict the future, we can only brace for it. We can be better at being disciplined. Understand that only through diversification can we mitigate some of the market risks and provide a smoother return stream in the future.
But you’re young and you don’t have a lot saved, so while seeing returns in the teens and twenty percent range can seem very appealing, consider that emerging market equities were down -14.9%, U.S. large cap stocks were flat and non-U.S. equities were down -0.8% in 2015. We have been in a prolonged bull run since 2009, can you afford to gamble on whether it will continue? Now if you are in your early 20’s to early 30’s you have something many don’t have which is a precious resource, time! That long time horizon should allow you to take risks, but it is important to understand what these risks are. Today, many apps like Robinhood, Acorns, Stash, Digit, etc. provide some form for you to invest small amounts of money into the market, but what they don’t often explain is that you are doing all of the work and taking all of the risk!
The average account size of Acorns is just over $400. Most users of these micro-investing sites start with $0 and slowly begin to contribute to their accounts via rounding up to the nearest dollar. Now to their credit these apps are helping individuals store money away from primary accounts, but they are also exposing the users to the market and the risks associated with it. Sure if a 9 year bull market continues then a user will likely be pleased, but if a 2008 type event occurs where emerging market equities, U.S. large cap stocks and non-U.S. equities were down -53.3%, -37.6% and -43.4%, respectively, will that same user start running for their mattress?
The fundamental point we try to make at Divvy is when you are starting with a small amount of money it is much more prudent to first save then invest. Why? Well beyond the aforementioned risks, how measurable is returning 20% on $400 vs. losing 20% on $400? Does the reward of making $80 bucks change your life? Unlikely, and while losing $80 bucks probably doesn’t change your life either, gambling with small numbers isn’t impactful. Now, if you had accumulated $400,000, the same exercise leads to a much more visceral reaction being up or down, perhaps even $4,000 would illicit a similar response.
So consider saving first. Reward yourself by setting attainable goals, not just for the long-term, but for the short-term as well. Setting shorter term, achievable goals will help create a mindset that you can achieve success and more immediate gratification. As you slowly begin to develop better, healthier financial habits you will find it easier to understand and explore investing. Accumulating a more meaningful amount to potentially invest will also create a more prudent behavior because no one likes losing money!