Millennials — that generation born between 1980 and 2000 — remember The Great Recession and the constant media reports of retirement accounts being decimated and stock markets falling worldwide in 2008. For a Millennial with her first paycheck or first real job, the idea of putting money into the stock market — a place that caused so much unhappiness only seven years ago — is scary.
Inflation Will Steal Your Money
Investing in the stock market is the most rational thing a person can do. Inflation right now is just about 1%, but it has historically averaged 2-3%. With savings accounts (even high-interest ones) only earning customers less than 1% on average, people may feel that their money is growing year over year, but it could quickly lose buying power if inflation increases. The S&P 500 however, has averaged around 10% return each year since 1928. Subtract the average inflation cost and the difference is the real rate of return.
Here’s a quick example. Let’s imagine a world with 3% inflation and $1,000 in a high-interest savings account. After a year, the money has earned 2% interest, meaning that the customer has $1,020. In reality, the value of the money (what the customer can actually buy) has decreased by 3%, which means that the diligent saver really only has around $990, a net loss of 1% (plus the taxes he would need to pay on the $20 gain).
If that same money had been invested in the stock market, even with a conservative rate of return of 6%, the investor’s money would grow from $1,000 to $1,060 after a year. Subtract the 3% inflation and he still has $1,030 in purchasing power (again, there’s tax to pay on the $60 gain). By putting money in the stock market, the investor hasn’t lost money like the saver.
The Stock Market Isn’t Scary
For a person who’s never taken a finance class, the idea of the stock market is fear-inducing. Terms like P/E ratio, stock-splitting, and debt-to-equity ratio get thrown around by the media and investment advisers; a person looking to start investing can easily become overwhelmed.
What’s the worst that can happen by investing? Stock prices do go down on occasion, but, in the long-run, the stock market goes up. Investing in individual stocks can lead to bankruptcy, but investing in a diversified portfolio leads to profit. (See also The Importance of Diversification.)
The best way I’ve ever heard someone explain how irrational it is to be afraid of the stock market is like this: While one or two stocks might head to zero, if the entire stock market goes to zero we all have bigger problems than losing money.
It’s easy to let emotions get in the way of making rational decisions. We all know to buy low and sell high, but, when facing a stock market correction, it’s tempting to act foolishly and to solidify the loss by selling. Likewise, emotions are what entice us to put money in “safe” (and potentially money losing) savings accounts, and emotions are why people buy houses when renting may be cheaper. (See also Reasons Renting is Better Than Buying.)
Investing Is Easy
Luckily, we all have access to the Internet, which makes it easy to invest rationally and wisely. The Internet has a plethora of resources for learning how to invest and for understanding different tax-savings vehicles available to Americans.
Also thanks to the Internet, discount brokerages will process your trades for a low cost. Online brokerages let people buy small numbers of shares or funds without having to worry (too much) about the cost of the transaction. Contrast that to a time before the Internet when full-service brokers would charge a high fee to conduct a single trade.
By starting to invest now, there’s another enormous advantage over someone who chooses to invest later” time. Time is advantageous to investors for two reasons. First, the power of compounding means that invested money will grow exponentially. The longer someone invests in the stock market, the greater her gains will be.
The second reason people need to start investing early is that time gives investors choice. Stock markets go up and down repeatedly, and if an investor needs her money now, she won’t be able to wait for the markets to go back up and could potentially lose a lot of money. Investing for the long-term is the best strategy, and the earlier a person starts to invest, the more time she’ll have to recoup any losses.
The Bottom Line
The most definitive way to explain to a person why she should invest is to provide a concrete example. In 2008, American stock prices plummeted. A potential investor, looking at the large drop in share price, would easily be convinced that her money is safer in a savings account.
Looking back though, we can see that a person who invested her money in an S&P 500 index fund at its peak price before the 2008 market crash would still be up 36% not including dividends. Sure, holding an S&P 500 index fund during The Great Recession wasn’t fun. It, along with every other stock, fell and lost money for a lot of people. However, with the benefit of time and long-term investing, the stock recovered and is worth much more than it was before the decline.