Investing in the stock market can be a great way to build wealth over time, but getting started can be intimidating. In this Fool Live video clip, published on Feb. 22, Fool.com contributor Matt Frankel, CFP, and Industry Focus host Jason Moser answer a listener's question about how younger investors with limited amounts of capital should start putting their money to work.
Jason Moser: We have a question from a listener this week, Matt, a question from Zee, and she's all the way in Malaysia. All right, so listen, we're reaching all over, all over the place. We're global here on Industry Focus, and love getting this question from Zee, and I've consolidated a little bit. But it's a good question and it's one I feel like we could talk about for a few minutes this week, because it is something that pertains really to younger investors.
Zee asks, "For younger investors like myself, how can we grow our portfolio when we're trading with smaller amounts of capital? Take the average millennials are earning, you've got a fixed monthly income of, say, $3,000 to $7,000, but considering student loan, rent, daily expenses, it's funny how people say we have a higher risk tolerance if were younger in age, when in fact, that's really all we have, and if we invest in the wrong business, sometimes it's a big deal. What if we want to grow our portfolio further or faster, is there a proper way to do so? What if we were to take more risks? What kind of risks would be easier or safer to manage?"
Matt, this really is something, I think it gets to really something we talk about a lot with younger investors often, is this idea of getting rich quick, and it's an understandable desire. Yet, you and I know, and it's something we focus on trying to teach our members, and listeners, and subscribers every day. It's just a lot easier said than done, it's really not the best way to go about things. Let's talk about this for a minute though, because I think she makes a really good point actually.
We do talk about often younger investors should feel like they can take on more risk, and the main reason we say that is because you have more time in front of you. You've got more time to work, and make money, and make up for potential losses. But at the time, in that immediate point in time, your resources are limited, so picking a loser is going to be something that can have a more dramatic impact on your finances earlier on in life. How do we square that up for her, in regard to the risk versus wanting to be able to get that portfolio to grow a little bit further, a little bit faster?
Matt Frankel: For one thing, I would push back a little bit and that you shouldn't have money in the stock market you can't afford to lose. Regardless of your risk tolerance, you shouldn't have money in the stock market that you, not just can't afford to lose, but you're going to need in the next few years. As a younger investor, you have that advantage that you won't need the money for a while. It's easier to make up losses if you're a newer investor. For example, when you get to be my age or Jason's age, and your portfolio gets cut in half, it can be devastating. At least a lot more so than when we were 25. I'm not 25 anymore, I don't think Jason is either.
Moser: [laughs] No, I'm not.
Frankel: It is all about time. But having said that, there's a real blurred line these days between risk and speculation. Especially in the gamified investing world that we've seen in 2020, the GameStops (GME -4.79%), the AMCs (AMC 3.48%), all the crazy stuff. All the SPAC mergers and all this kind of stuff, it's just become a game to a lot of people, and you have to really manage risk. If you're a younger investor starting out with a relatively small portfolio, chasing things that are going to double in a year or two, or going after the next big thing, or even putting one or two stocks in your portfolio because you think they are the way to go, is not the right way to do it.
First establish a base, I always tell people that the lowest risk, highest reward thing you can do is to start a base of just high-quality ETFs in your portfolio. An S&P 500 ETF will historically return 10% a year over the long run, but it's not going to make you broke. If you're in your 20s, 10% compounded over a lifetime is a really good return. A really good return. You don't need to save that much in your account if you're investing in something like that to end up a millionaire. But you're not going to go broke doing that. Once you've established a base, that's when you branch out into individual stocks and things like that. But even then, it's important to remember that it's not a game, this is actual money that you're putting up. This is the money that you're going to need to send your kids to college, or to fund your retirement, or to, in Jason's case, buy a horse, [laughs] or whatever you want to do. Jason wouldn't have bought the horse if he had been irresponsible with his money.
Moser: No, I reckon not. I didn't put the horse on a credit card, I paid cash.
Frankel: You didn't sell your GameStop stock to buy it.
Moser: No, I did not. [laughs]
Frankel: I'm guessing it came from wise financial planning.
Moser: I'd like to think so.
Frankel: The point is, establish a base. Don't take unnecessary risks. Know what you're getting into. Don't speculate, that's the wrong word. You want to invest, you could take on risk. Apple (AAPL 2.45%) stock is a risk. Buying GameStop because it was on a Reddit board is speculating.