Why Young Investors Shouldn't Dabble in Stocks
New investors can avoid pitfalls with the right tools.
Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. One phenomenon we're experiencing during the pandemic is seeing more young people investing directly in stocks. But is that a good idea? Joining me today to discuss is Christine Benz. Christine is Morningstar's Director of Personal Finance. Christine, thanks for joining me today.
Christine Benz: Susan, it's great to be here.
Dziubinski: We've seen a lot of reports in the media about how young people are dabbling in stocks today. First, you know, can we really call this a trend? And secondly, what do you think is behind it if it is a trend?
Benz: It's hard to say, Susan. I looked for some quantification of the trend that we've been hearing so much about. There has been an indication among some of the brokerage platforms that they've been seeing a lot of new account applications. They began seeing them in the early part of this pandemic. So that's one indication. Robin Hood has certainly taken off as a platform for younger investors. That's a free trading application.
And I think that you could probably chalk it up to a few different factors. One is that most of us have some extra time on our hands, so it could be that. It could be that not having other forces competing for our spending has given younger folks some discretionary cash. And it's also worth noting that some of the apps like Robin Hood have done a good job of kind of gamifying investing in the market. So they've made it fun, they've made it playful. So I think it's probably engaged some young investors on that level.
And then we saw this really dramatic market action in the first half of 2020, where we had a dramatic sell-off and then really almost immediate gratification after that period. So perhaps younger investors were intrigued by that idea of, "I can buy X really cheaply and see it recover very quickly." So I think it's a confluence of factors.
Dziubinski: So if you're a young person who's new to investing, from your point of view is it really a good idea to start by investing in individual stocks?
Benz: I've really wrestled with this, Susan. I tweeted like a month ago that I think it's actually a suboptimal way for young investors to get started. And I received a lot of pushback, actually. People I really respect said, "Well, this is the way that I learned how to invest. This is the way I learned how stocks and the market work." And I appreciate that perspective, but I guess my counterpoint is if you're young, if you're say you're in your 20s or something like that, we've all seen the charts about how impactful compounding can be if you get started early. So my thought is that while young investors have that long runway, if they can get started in assets that can really give them a good shot at appreciation, so if they can invest in a diversified broad basket of equities, that probably gives them a better runway to earn good long-term returns over their very long time horizon. So my advice would be to skip the individual stock investing and move straight to a broad basket, maybe an index fund or a target-date fund.
Dziubinski: What else then? If we're talking about index funds and target-date funds, what else should young investors be keeping in mind as they're first going out into the market?
Benz: Well, I think they would want to keep in mind short-term goals because many of these young investors certainly are not investing for retirement. They're investing for new home purchases, buying a car, whatever it might be. And so I think if you're working with a young person in your life, you're talking to them about how to get started in investing, make sure that they understand the importance of segregating money used for short-term goals in something safer than stocks. Maybe talk to them a little bit about this sort of bucketing concept, if you will.
And I think it's also important to talk to young folks who have a salary about the virtue of using some tax-sheltered investment vehicle to do their saving. If they're employed and they have a workplace plan, they may have a 401(K) match. If they're not offered a workplace plan, anyone with earned income can do a Roth IRA up to the amount of earned income. So talk to them about the value of using some of those tax-sheltered receptacles. And also talk to them about the value of having that rainy day fund, because one thing we've seen through this crisis is that people really struggle with this, with setting aside liquid reserves to tide them through disruptions in their income or emergency spending that they might have to do. So I think if you have someone near and dear to you, explain to them the virtue of making sure that you have those short-term reserves on hand.
Dziubinski: Speaking of, let's say you are a more seasoned investor, and you do have someone near and dear to you who's younger who has caught the investing bug, and you want to help out. What resources would you recommend for that seasoned investor?
Benz: Great question, Susan. And so one thing I would say is help them graduate from Reddit, where a lot of younger investors seem to be getting their information. Morningstar.com obviously I think is a fantastic resource. Bogleheads is a fantastic resource for investors of all ages. I would also recommend a couple of books. I love the “Bogleheads Guide to Investing.” It's not new, but I think there's a lot of great evergreen information there. One book I like for younger investors is “I Will Teach You to Be Rich” by Ramit Sethi, and it's just a terrific book about the importance of saving, the importance of frugality, and that ties in in a lot of ways with the F.I.R.E. movement, which I think in a lot of ways is a healthier thing for young investors to think about, to really understand the importance of personal savings, of saving as much of your income as you possibly can. So I think that some of the F.I.R.E. blogs can be really helpful in that context, as well as sort of a counterpoint to the day-trading mentality that seems to be taking hold in some younger investor communities.
Dziubinski: Well, it's interesting because at Morningstar we're big advocates of getting started early and letting compounding work for you. But day trading is probably not the way to do it.
Benz: No, it reminds me, Susan, of so much of the early 2000s/late-1990s period, where everyone had to have a brokerage account and many investors had predictably awful results because they were just performance chasing. They were chasing Cisco and the latest dotcom stock, and many investors did not end up being successful with those positions. So I think starting broadly diversified makes a world of sense for a young investor.
Dziubinski: Well, Christine, thank you so much for the perspective today. We appreciate it.
Benz: Thank you, Susan.
Dziubinski: I'm Susan Dziubinski for Morningstar. Thank you for tuning in.