When it comes to investing, the younger generation is falling behind. And who can blame them? For most, they witnessed the tail end of the great bull market in the 1990’s, only to witness the stock market come tumbling down during the dot com bust. Follow that with the recession after September 11 and then the next recession in 2008. The stock market has rocketed ahead once again, but many younger investors are fearful of putting their money in because they are expecting another drop in the market.
So what should younger investors do? It’s easy to say “just invest”, but there has to be a good reason to otherwise, they will continue to sit on the sidelines. Here is how to play it safe while still investing in the stock market.
Keeping A Cash Stockpile
It’s important to have an emergency fund. No one is going to suggest otherwise. Ideally, you should have around 6-8 months worth of expenses saved up in your rainy day fund. But, you may be comfortable needing more. For some, you have low paying jobs or are nervous about the potential of losing your job and want more savings in cash. This is perfectly acceptable.
Don’t get caught up in reading about how this is how you should do things and if you aren’t doing it this way, it’s wrong. Personal finance is personal. This means what works for me, might not work for you. This is OK, you need to do what allows you to sleep at night.
For example, my wife needs to have a much larger emergency fund than I do. It’s because of what happened to her while growing up. If she has less than a certain amount, she gets nervous. I accept this because it is what makes her happy. In the long run, her being able to sleep at night is worth it to us.
Learn what the typical guidelines are and then make some adjustments so that you are comfortable and can sleep at night.
Don’t Keep Everything In Cash
With that said, you shouldn’t have all of your money in cash. You need to invest some of it. Here is why: when you keep your money as cash, you are losing money. Not in the sense that you will have less money, but in terms of purchasing power.
Here is what I mean by this. When you have $10,000 in the bank, you will always have $10,000 in the bank. You need not worry that it will drop to $7,000. But, that $10,000 is a false comfort. This is because inflation works against you. In basic terms, inflation is the thing that makes prices rise. Every year on average, prices rise 3%. This means that you need 3% more each year just to keep living the same lifestyle and afford everything you currently buy.
If your cash is earning you less than 3%, you are losing money every year. If you have $10,000 and inflation rises at 3%, next year you need $10,300 to afford the same standard of living. If you didn’t earn 3% last year in your cash (and chances are you didn’t) then you have less money than you need.
While this doesn’t seem like a huge issue now, in time, it becomes one thanks to compounding.
The Solution: Investing
The only way you are going to combat inflation is by investing your money. Now, I realize that you might be scared, thinking about all of the times the stock market has dropped. But let’s focus on the positive for a minute ñ in every instance where the stock market has dropped, it has come roaring back.
Will the market drop again? Sure it will! Will it come back? I’d say it is more than likely that it will. You need to stop focusing on the short term events in the market. Look at the long term. The money you invest in the stock market isn’t for an emergency or for the short term. It is for long term savings. Because of this, you need to focus on the long term when it comes to investing.
Over the short term, there will always be volatility in the stock market, but over the long term, the general trend is positive. Focus on the long term and you will be much happier and less worried when the market drops in the short term.
Having cash on hand for emergencies and to provide you with comfort is a good thing. But having all of your money in cash is a bad idea. You need to invest your money in the stock market, not only to keep ahead of inflation, but also to help you reach your goals. You are never going to afford retirement when you are only earning 1% on your money.
Find an amount of cash that makes you comfortable to have in the bank and then slowly start investing for the long term. Do your best to remember to focus on the long term and accept short term volatility. It is always going to be there. Look at it like speed bumps on the highway. The ride isn’t smooth 100% of the time, but you get to your destination 99% of the time without incident. The same applies to investing. There will be bumps along the way, but over the entire journey, the odds are in your favor of reaching your destination.