Investing Strategies for Young People

A person holds a bond in one hand, but their focus is on the smartphone in their other hand with a social media feed visible. The feed shows a flat growth arrow with some emojis in the background.

Those who are just beginning to save or are young investors need to become familiar with certain principles. One of the most important is to start early in order to give compounding the time to do its thing. Keeping costs low is also essential in order to protect the gains. Diversifying is another must; attempting to time the market should be left to the professionals. Even if prices drop drastically and it appears that the world is ending, remain disciplined and stick to the plan. Additionally, do not be tempted to jump on the bandwagon of certain assets during times of market success; it is not worth the risk of ruining what has already been accomplished.

 To the already long list of lessons to be learned, a particularly discouraging one can now be added for today's generation: what your parents achieved financially will be hard to replicate. Even taking into account the global financial crisis of 2007-09, the 40 years up to 2021 have been a prosperous time for investors. A general index of global stocks has had an average annual real return of 7.4%. Not only was this substantially higher than the 4.3% of the preceding 80 years, but it was also accompanied by an impressive performance in the bond market. In the same time frame, global bonds have seen real returns of 6.3% each year - a significantly better outcome than the 0% of the previous 80 years.

 It appears that the period of prosperity has come to an end. The prosperity was initially generated by globalisation, low inflation, and the long-term decline in interest rates. Unfortunately, these trends have reversed. Consequently, young people are now faced with a more complex set of decisions when it comes to investing--such as how much to save, how to get the most out of markets that offer less, and how to reconcile their moral values with the pursuit of returns. Unfortunately, many are making ill-advised choices.

 The popular adage that past performance is not a predictor of future returns is proving to be true now more than ever. If market returns were to revert to their long-term averages, the consequences would be particularly severe for younger investors (those aged under 40). Historically, stocks and bonds have returned 5% and 1.7% respectively over the long-term. After 40 years of these returns, $1 invested in stocks would be worth $7.04 in real value, and $1.96 in bonds. But those investing between 1981 and 2021 would have seen their $1 grow to $17.38 in stocks and $11.52 in bonds.

 Two threats now loom for new investors. Initially, they may analyze past history and assume that investments will bring them more riches than would be likely over an extended period. This, then, could lead to them saving insufficient funds for their retirement, with the expectation that returns from investments will fill the gap. Even more disheartening is the fact that lengthy periods of generous investment returns could have not simply provided investors with exaggerated expectations, but could also make it more probable that future yields will be meager.

 In his book "Investing Amid Low Expected Returns", which was released last year, Antti Ilmanen of AQR, a hedge fund, explains this concept by looking at the long-term decrease in bond yields since the 1980s. This decrease in yields caused a corresponding price increase, which is why bondholders experienced high returns over this period. Yet, as the yields approach zero, there is less and less potential for capital gains. This has been especially evident lately, as the nominal ten-year American Treasury yield has risen from 0.5% in 2020 to 4.5% currently, which is significantly lower than the close-to-16% yield of the early 1980s.

 When it comes to stocks, dividend and earnings yields (the main sources of equity returns) declined with interest rates. This eventually led to shareholders enjoying added value from their investments. Essentially, this was because previous returns were brought to the present, raising prices and diminishing the potential yields that future investors could get from dividends and profits. Unfortunately, this came with a price, diminishing the returns for the next group of investors.

 Last year's market crash had one benefit: yields on government bonds moved from negative to positive, as did those on corporate bonds. However, a rise in interest rates carries the potential danger of companies defaulting. Steve Schwarzman, head of Blackstone, summed up the opportunity: "If you can earn 12%, maybe 13%, on a really good day in senior secured bank debt, what else do you want to do in life?"

 An image that was featured in The Economist can be seen above. It shows the need for a global climate change response. The urgency of the situation is highlighted in the picture, as evidenced by the melting glaciers and rising sea levels. This image serves as a reminder to take immediate action in order to help the environment.

 Despite a strong recovery in stock prices this year following a drop in 2019, the long-term outlook for equity investments remains bleak. The equity risk premium, or the expected return on stocks over "safe" government bonds, has hit its lowest point in decades. Without highly unlikely and sustained growth in earnings, the only options are a crash in prices or years of unimpressive returns for the S&P 500 index of large stocks.

 Given the current market conditions, it is especially important for young savers to make wise investment choices. Fortunately, they have more access to financial information, convenient investment platforms, and cost-efficient index funds than any other generation. Unfortunately, many of them are falling into traps that will diminish their already minimal returns.