It's hard to beat the stock market as a way for people of average means to build significant wealth. You can start with small sums, and if you're diligent and keep learning, you can amass a fortune over the long run. Many have done it.
It's generally true that there's no better time to start investing than now -- but what if "now" is during a pandemic? How should you go about investing in the stock market during this ongoing coronavirus crisis? Should you even start now?
For many people, the answer will be yes -- go ahead and get started building long-term wealth through stocks. Here's a look at some things to consider and first steps to take.
Tips for new investors
Most of the best advice for new investors doesn't change from year to year, and it's the same whether there's a pandemic afoot or not. Here are some key tips for new investors:
Set reasonable expectations
Start off by reading and learning enough about investing that you have reasonable expectations. Yes, stocks such as Amazon.com and Netflix have doubled and tripled and sextupled and septupled and more over the years, but that's not the norm -- and even those stocks didn't rise in a straight line. Over many decades, the U.S. stock market has advanced by close to 10% annually, on average -- though there are decades when it has done poorly and some individual years when it has gained by more than 20%.
For best results, you'll need to be very patient -- your fortune in stocks is likely to be made over decades, not months or even years.
Have an emergency fund
You need to be ready to invest, too, which means, for one thing, having an emergency fund, stocked with about three to nine months' worth of living expenses, in case your household loses a job or suffers a costly health setback.
Be free of high-interest-rate debt
You also need to be free of high-interest-rate debt, such as credit cards can give you. They frequently charge 20% or 25% or more annually, and if your investments are growing by, say, 10% annually while you're paying 20% or more on your debt, you can end up shrinking your net worth, not growing it. So get out of debt as much as possible before investing. (Mortgage debt and low-interest-rate debt are not as problematic.)
Consider index funds
Next, while you might imagine that stock market investing involves spending hours studying the universe of stocks and carefully deciding which ones to buy and when to buy and sell them, it doesn't have to be so complicated or so much work. As investing icon John Bogle has advised, "Don't look for the needle in the haystack. Just buy the haystack!" Bogle happens to be the father of the index fund (and founder of Vanguard, famous for its low-cost index funds).
Most of us should consider just parking most or all of our stock market dollars in an index fund that tracks a stock market index such as the S&P 500. It's simple, easy -- and even powerful: Index funds tend to outperform their managed-fund counterparts over time. So consider a simple low-fee broad-market index fund such as the SPDR S&P 500 ETF (SPY -2.21%), which will spread your money across 500 companies that make up about 80% of the U.S. stock market's value.
If you want to invest in individual stocks, then definitely keep reading and learning about investing -- and don't stop. As Warren Buffett's partner Charlie Munger has noted, "I constantly see people rise in life who are not the smartest, sometimes not even the most diligent, but they are learning machines. They go to bed every night a little wiser than they were when they got up and boy does that help, particularly when you have a long run ahead of you."
You can find a lot to read at Fool.com, and it's smart to read at least a few great investing books, too, such as Common Stocks and Uncommon Profits by Philip Fisher, One Up on Wall Street by Peter Lynch, The Little Book of Common Sense Investing by Jack Bogle, and The Little Book That Beats the Market by Joel Greenblatt.
What's different in a pandemic?
Returning to the pandemic environment we're in, how might it affect your entry into the stock market? Well, it triggered a big stock market crash that presented many bargain-priced stocks, as market crashes always do. Even shares of Amazon.com dropped by more than 15% over the course of about a month, and many stocks fell even more sharply. The market has regained much of what it lost, though, and Amazon shares have recently been near all-time highs.
We're not out of the woods yet with the COVID-19 crisis, and one or more big market drops may still be ahead in the near future -- and some are definitely in the further-off future, as occasional drops are inevitable. So keep that in mind. Don't worry that you missed out on the best opportunity, because there will always be opportunities.
Keep your emotions in check -- that's important throughout your investing life, but especially during times of volatility in the stock market. Don't let fear or panic make you suddenly sell out of healthy and generally growing companies, and don't let greed make you snap up shares of stocks that have surged to overvalued levels.
If you're nervous about investing in the stock market now, then don't do it. But keep reading and learning until you're comfortable with the idea. Or consider easing into it. If you might have started with a $6,000 investment, you might invest $2,000 now, another $2,000 in a few months, and the final $2,000 some months later. Indeed, for best results investing, you should be adding money to your portfolio regularly for decades.
Times like these tend to remind us how important emergency funds are, so do be sure yours is stocked with enough to support you for many months, in case it has to. Spend a little time imagining some worst-case scenarios. If you lose your job, what will you do? What other income sources might you pursue -- now and/or later? Can you do a better job of living below your means now?
Finally, remember that pandemic or no pandemic, you should never invest in the stock market with any money you will or may need within five (if not 10) years. You don't want to have to sell stocks after they've crashed, and the market's performance in the short term is unpredictable -- but over the long run, it has always gone up.
This pandemic period is a great time for some to start investing -- just be sure to keep your big financial picture in mind and make sure that you're prepared for possible good times and hard times ahead.