Independent SEC-registered investment advisor at Stonnington Group, a wealth management and investment planning firm based in Pasadena, CA.
Over the next 10 to 20 years, American millennials will inherit $30 trillion from boomers in the largest generational wealth transfer in U.S. history. The impact of the Covid-19 pandemic and potential changes to estate tax legislation might even accelerate this timeline. This means that millions of millennials could receive large inheritances before they’ve developed a smart investment strategy.
It’s important to understand different investment strategies and how each fits with an individual’s goals, timeline and personality. Even as the world goes through radical changes, certain foundational principles hold true.
Timing The Market vs. Time In The Market
There’s an old maxim that says it’s time in the market – not timing the market – that matters. In order to generate wealth by timing the market, investors need to be smarter than the market, which, according to efficient market theory, isn’t a sustainable strategy. This approach pairs the potential for large gains with the likelier potential for large losses.
Prioritizing time spent in the market by simply buying and holding quality stock is much less likely to generate enormous short-term gains, but it can generate long-term wealth, since the market has historically increased in value over time.
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One of the biggest problems financial advisors face is that they inevitably have to time the market to a certain degree. This is because the client ultimately decides when they are going to invest. Therefore, a large lump sum investment may underperform initially, if an investor entered the market at a particularly unfavorable time.
This doesn’t mean that investors shouldn’t invest a lump sum all at once. An alternative approach would be to invest a large sum in tranches over time. This way, investors can hold out to buy stock when the market is down. The downside to this approach, however, is that investors who are sitting on cash also lose out when the market goes up.
Because the market has historically increased over time, it may be wiser for millennials to invest a large sum all at once. If an investor has a long time threshold before they need that money again, they can invest now and let the market take care of the appreciation over time, without continuously trying to outsmart the market.
Buy And Hold vs. Active Investing
When you buy and hold stock, you avoid the risk of timing the market because you’re invested for the long haul. Instead of gambling on the short-term success of a stock, you invest in its ability to endure inevitable market downturns and generate wealth over time. This means investing in companies positioned for survival and growth, with strong, adaptable business models, management teams possessing the skills and intent to take advantage of future innovation, and the potential to dominate the market.
In contrast to buy and hold, an “active” investment strategy means portfolios can be adjusted on a frequent or even daily basis to take advantage of every opportunity for short-term value gain. Successful active investing can make investors a lot of money, but with significant risk that compounds over time and the additional cost and tax consequences of frequent trading.
Though far less frenetic than active investing, buying and holding shouldn’t be considered a passive, inactive or low-growth strategy. A well-designed buy and hold portfolio commonly contains stocks that could grow 1,000% over time. It’s also important to periodically update a buy and hold portfolio to avoid “vintage” stocks that are past peak growth while capturing new investment categories that are poised to grow well into the future.
Huge Returns vs. Huge Losses
Will Rogers once said, “The way to make money in the stock market is to buy a stock. Then, when it goes up, sell it. If it’s not going to go up, don’t buy it!” On the surface, this advice is comically simple, but it’s an important reminder that investors cannot undervalue how important it is to avoid the risk of oblivion.
Because you need money to make money – at least in the stock market – one shouldn’t invest where they could potentially lose all of their money. Investors chasing huge returns can easily incur huge losses. The average investor may end up with higher returns overall by making above average returns consistently versus making huge returns occasionally.
Lost money is difficult and expensive to recoup. For example, if you bought a stock for $100 and it dropped 50% to $50, it would have to increase 100% just to break even. Diversifying asset classes through index funds and blended portfolios is a useful way for investors to avoid losing money.
When it comes to buying stock, a time-tested strategy is to avoid the losers and let the winners take care of themselves. Winners are companies with long-term growth prospects – typically those with market cap in excess of a billion dollars – which are still small cap companies that have already been tested in the market.
Investors who take this approach still need managers to monitor their investments and cull underperformers. Even conservative investments are unpredictable. Companies can be acquired or go out of business. Stocks rise and fall, but that doesn’t mean investors should ride a stock all the way down when it’s apparent that they could either take a small loss or a large one.
It’s not just an investor’s approach but also his or her intention that matters. This means a strategy like buying and holding becomes buying with the intention of holding – as well as the agility to make smart adjustments and the determination to win over the long term.
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.