8.1 The “young” investor
The “young” investor mindful plan
In previous articles we found that stocks are preferable to other common investments, when we use mindfulness to help weather routine stock volatility. Over a sufficiently long time horizon, stocks almost always achieve superior returns. As a result, for the “young” investor, the plan for investing over time is pretty simple:
- Invest in a simple, low-cost, and diversified set of index funds consisting almost entirely of stocks. (The Article 7 series discusses examples of such stock funds.)
- Keep investing in stocks as new money becomes available and hold all your stock purchases come hell or high water until you get close to being an “old” investor as defined in Article 8 (i.e., within 5 to 10 years of retirement).
That’s a pretty darn easy plan to understand and a simple one to execute for a good chunk of your life.
Plan mechanics – There are many books and websites out there that describe how to save money over time and the mechanics of investing in stocks. A good starting place is J.L. Collins book The Simple Path to Wealth. This and other similar resources address things like: saving large portions of your income, using taxable versus tax advantaged accounts, opening and using brokerage accounts, avoiding unnecessary investing fees and taxes, etc. Although these are important details, the Mindfully Investing website does not have much new or different to add to these mechanics. Mindfulness is very relevant to controlling spending and saving habits, but that is also not my primary focus. I will likely add some blog posts in the future that cross into the whole saving, frugality, and spending discussion, but we can leave that aside for now.
Advantages of automation – One aspect of investing mechanics is worth mentioning here. Probably the best way to help ensure you actually follow the mindful plan for the “young” investor is to automate the process as much as possible. The goal of automation is to hardly think about your investing process once you’ve set it up. If your long-term investing is mainly through your company’s 401K plan (or similar), you can usually have a set amount automatically deducted from each paycheck and then automatically invested into a diversified set of low-cost index stock funds. Even if you don’t have access to a 401K plan, you can set up similar automation with your bank that deducts a certain amount each month to a savings or cash account. That savings account can then be linked to automatically transfer set amounts per month to a brokerage IRA or taxable account, where the money can be automatically or nearly automatically invested in low-cost index stock funds.
Automating your investments makes it even harder for you to temporarily stray from your investing game plan because of emotional turmoil. This is sometimes referred to as the positive effect of “inertia”. For example, it’s been found that simply changing the default option in setting up new 401K accounts from “opt out” to “opt in” can greatly increase people’s participation in such plans. Similarly, when the default options are set to higher contribution percentages and more aggressive assets (stocks), people tend to accept these options. As a result, their account values are generally higher than when using more conservative defaults. Even if you are not particularly mindful on Tuesday, it takes quite a few steps and time to disable or alter all this preset automation. This inertia increases the chances you will decide not to bother with the changes when you return to being more mindful on Wednesday.
The mindful investing plan for “young” investors includes one technique often recommended in popular finance websites and books, so called “dollar-cost averaging”. The idea behind dollar-cost averaging is that, as you accumulate savings and invest chunks of money over time, you are necessarily buying sometimes when the market is down (and perhaps relatively “cheap”) and sometimes when the market is up (and perhaps “expensive”). Automated stock purchases on a regular schedule increases the likelihood that the overall cost of your stock portfolio is not particularly expensive. But by the same token, it won’t be absolutely cheap either. Dollar-cost averaging has become popular because investors are starting to understand that you can’t really “time the market” and expect to consistently buy stocks cheaply, which is discussed more in Article 8.5.
Because the stock market generally goes up 70% of the time, the longer you wait to invest, the more likely it becomes that your stock purchases are more expensive, which will lower your overall return. Given that most people in the “young” category usually receive income on a weekly or monthly basis via paychecks or similar income streams, dollar-cost averaging (DCA) is a normal by-product of investing at regular intervals. Vanguard studied this issue and generated the graph below.
Vanguard found that about 67% of the time a lump sum investing approach would out perform a dollar-cost averaging approach. This result echoes the observation that the stock market goes up 70% of the time, although likely for coincidental reasons, because the Vanguard study also included bonds.
Just to be sure, the blogger “Actuary on FIRE” conducted an even more detailed analysis of dollar-cost averaging, which examined varying investment periods and stock/bond mixes as well as adjusting for inflation. The main results are shown in this graph.
The percentage of time that lump sum investing outperformed dollar-cost averaging varies depending on analysis period and portfolio construction. However, `lump sum investing is more likely to outperform dollar-cost averaging for all the scenarios considered.
So, telling yourself that your stock purchases were not particularly expensive on average is a nice story to help you fall asleep at night, but in reality, your long-term returns may suffer because of dollar-cost averaging. On the other hand, it’s possible that you may end up in a situation that generates the less likely outcome where dollar-cost averaging outperforms lump sum investing. Given the unpredictability of market movements and that neither lump sum nor dollar-cost average investing has a clearly superior track record, a mindful view suggests that worrying about dollar-cost averaging is wasted time, like most worrying. And because most “young” investors don’t have a choice but to dollar-cost average, you can pretty much forget that this concept even exists.
The next article (Article 8.2) on the “old” investor covers how to invest over time when the investor is near or within the spending phase or retirement. As we will see, making regular withdrawals from a portfolio for spending needs complicates investing over time.