Peter Hodson: ‘Buy the dip’ isn’t the best advice for young investors
The best time to invest is when everyone else is panicking. Just don’t try to time the market. Photo by Brendan McDermid/Reuters files We’re getting a few questions from customers lately on how a young person should start investing. It is, of course, ironic that these questions are coming in the midst of a giant stock-market correction, one of the fiercest, and one that’s making even seasoned investment professionals quake with fear. But we love it. The best time to invest is when everyone else is panicking.
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Young people flock to the shopping mall when there is a sale (well, they used to, pre-pandemic), so why not flock to the stock market when it is on sale?
There are dozens and dozens of suggestions one could make to a new young investor. Some are good, some are bad, some are conflicting. Let’s look at five and put them through the grinder.
Always keep six months of cash on hand for emergencies This rule can make sense when you are older and have a lot of fixed expenses and/or a mortgage. But young investors don’t generally have a lot of excess cash in the first place. If you have a big cash cushion on hand for emergencies, it’s not very likely you will have much left over for investing.
Assuming a young adult has a job, we would skip this so-called rule and start investing as early as possible. The best time to invest, as they say, is yesterday. This cushion-of-cash rule can also be a bit relaxed these days, because there are 11 million job openings in North America right now. If a new investor loses their job for some reason, they are likely going to be able to find another one, very quickly.
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Article content Avoid advisers and high fees at all costs This rule is tricky for us, since our company specifically helps DIY investors, and adviser fees can indeed be a big drag on a portfolio’s performance. But we would rather see a young investor work with an adviser in order to position themselves properly than see them make all sorts of mistakes in their early investing days.
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You are young, so use leverage to maximize returns Um, no. We have seen this rule a few times, the idea being that a young person has the time to stick with investments and get good long-term returns. A young investor also tends to grow their income with time. Thus, leverage can increase returns and can be covered if things go south for a while.
But we think this is a horrible idea. Using leverage to buy investments when starting out is only going to stress young investors out more. Trust me. I once (at 23, after the crash of 1987) had to cover a margin call with a credit card. Leverage can be a wonderful thing when the market is rallying, but it can be downright deadly in a downturn. We would never suggest using debt for a young investor just starting out.
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Article content Invest in what you know We don’t mind this rule, but it can’t just be applied willy-nilly. If I followed this advice in the ’90s, I would be stuck with a bunch of worthless Blockbuster Video shares today.
“Invest in what you know” can turn out to be pretty bad advice. Photo by QMI Agency Young people can identify trends amongst their peers, but this does not always translate to investment success. Homework is needed, and young investors may not be so good at doing their homework. But it can certainly work at times: my two daughters loved Aritzia Inc. stores, so we covered the company, and that stock has tripled in the past three years.
Buy the dip This is not the best advice for young people, which might seem contradictory if you recall our opening paragraph that suggested buying stocks when they are on sale. But it is not. Buying the dip is essentially just another form of market timing. Dip buyers are assuming the market will bounce after the dip. It may, it may not. But it is a form of timing, nonetheless, and we absolutely do not think investors should attempt to time the market.
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Article content We would change this bit of advice to “buy consistently.” Invest every month, every quarter, whatever you can, at regular consistent intervals, with consistent purchases. When the markets drop, your investments will buy more (exchange-traded funds, stocks). When the markets are high, your dollars don’t go as far. It turns volatility into your best friend, rather than something to fear.
Peter Hodson, CFA, is founder and head of Research at 5i Research Inc., an independent investment research network helping do-it-yourself investors reach their investment goals. He is also associate portfolio manager for the i2i Long/Short U.S. Equity Fund. (5i Research staff do not own Canadian stocks. i2i Long/Short Fund may own non-Canadian stocks mentioned.)
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