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The first decade of the new millennium is over, but it's left a lasting impression on an entire generation of young investors. Although older folks clearly remember long periods of huge gains for the stock market, those who started investing at or after the tech bubble peak in 1999 and 2000 aren't sold on the theoretical idea that stocks are always the best investment for the long haul. In fact, many younger investors have steered clear of the stock market entirely.
But regardless of what you think of the future of the stock market, one thing is pretty clear: Earning 1% in your bank savings account isn't likely to get you any closer to retiring. Smart investing requires taking some risk -- and even if you're scared of the recent history of the stock market, you can find ways to get exposure to stocks without taking on the full brunt of stock risk.
A generation at risk
You can't blame younger investors for hesitating before putting themselves back in the line of fire. Having seen stock investors get seriously burned not once but twice during the 2000s, no one has seen the risk side of the risk-reward equation more intimately than those who started investing in the past 10 years.
In addition, since younger investors typically have the longest time horizons before needing their money for long-term financial goals like retirement, they often invest extremely aggressively. Unlike those approaching retirement age, who need to have the protection of lower-risk investments like bonds to protect against severe downturns, younger investors can theoretically afford to take massive risks with all-stock portfolios. That can lead to superior long-term returns during good times, but as many discovered in 2008's market meltdown, it can also leave your portfolio completely vulnerable to severe bear markets.
As a result, some investors saw their account values cut in half during the worst of the financial crisis. And in response, some of them are calling it quits for stocks.
Get back in -- carefully
The problem younger investors face is that their alternatives won't let them get away with long-term, low-risk investing. Even long-term bank CDs only pay around 2.25% on average. That's not even enough to cover taxes and inflation, let alone give you any real progress toward your financial goals. And while it's better than losing your shirt, conservative investments give you absolutely no chance to participate in the growth that promising stocks offer.
If you know you should invest in stocks but are still scared, there are ways to ease yourself back into the market. Here are a few of them:
- Steer clear of volatility. The scariest thing about stocks is just how quickly they can move down during bad times. But some stocks don't move as much as others. Large-cap stocks with low betas won't give you the supersized returns that more aggressive growth stocks will, but they'll help you sleep at night. Altria (NYSE: MO ) , General Mills (NYSE: GIS ) , and Colgate-Palmolive (NYSE: CL ) are well-known companies with less than half of the volatility of the market, yet they've all provided cumulative returns of at least 50% over the past five years -- far exceeding the broader market's return.
- Stick with value. Stocks with cheap valuations offer a margin of safety for investors, as long as those valuations don't reflect inherent problems with the stocks in question. Abbott Labs (NYSE: ABT ) and Intel (Nasdaq: INTC ) trade at low multiples to earnings, and fellow Fool Matt Koppenheffer believes their shares are really worth quite a bit more than their current share price.
- Take an option. Options are often seen as the riskiest way to invest, but in reality, they let you tailor your risk precisely to your own preferences. For instance, if international stocks appeal to you but buying shares of international ETFs iShares MSCI EAFE (NYSE: EFA ) and iShares MSCI Emerging Markets (NYSE: EEM ) make you nervous, buying call options on those ETFs will cost you just a fraction of what you'd pay for shares, limiting your downside but still giving you most of the upside potential from a bull market.
Do it soon
Already, those who were spooked out of stocks by the bear market have missed out on a huge rally. That just proves how difficult it is to time the market -- and how important it is to stay invested. By dialing up exactly the right risk level for your stocks, even skittish investors can feel comfortable taking positive steps toward reaching their financial goals.
Dividend stocks are also a fairly low-risk way to play stocks. In this free report on dividend stocks, our Motley Fool analysts have identified 13 dividend-paying stocks that are good long-term plays. To download for free now, just click here.