The Stock Market Keeps Rising—Here's Why Small Investors Need to Watch Out
The indexes are up, up, up. But how long can this possibly continue?
In the dizzying world of investing, stocks seem to steamroll forward. And in 2021, the popular collections of stocks called indexes are all up, up, up. Over the last 12 months leading to early March, that means 21% for the Dow, 29% for the S&P 500, and the Nasdaq's astounding 54% run. And yet, tens of millions of Americans in the real economy have been battered.
While investing is always good, doing so with an eye on reality is better. There are multiple reasons why stocks have seen such gains—and no guarantee how long that might continue.
"The stock market isn't necessarily a reflection of what's happening on Main street," says Greg McBride, chief financial analyst at Bankrate.com. "Markets are forward looking, and the stock market is comprised of much larger companies than the mom-and-pop stores on Main Street that are suffering so terribly in the pandemic."
Over the long haul, the stock market is a great way to build wealth. Or, as Robert Johnson, a professor of finance at Creighton University's Heider College of Business puts it, markets are a funny kind of rigged game. "It's like a casino, but instead of it having a bias for the house, it has a bias for the investors," he says. "Since 1926, stocks advance about 10.2% compounded annually."
That's a great return—in the long run. Shorter term, things can get uglier. Finance experts call the 1990s the Lost Decade, because conditions left stocks flat over the 10 years.
"Some years they go down 30% or 40%," Johnson says.
That clearly isn't the current case for stocks—although it was just last year. The Dow, S&P 500, and Nasdaq respectively lost nearly 35%, 31%, and 24% between the beginning of the year and March 23, according to data from S&P CapitalIQ.
Reversals can happen when investors least expect them. How soon we can forget.
What's driving markets now
"We've experienced a very unusual year in the markets," says Lauren Goodwin, multi-asset portfolio strategist at New York Life Investments. "Investors find themselves at very powerful cross currents."
Low interest rates over a dozen years have meant investors found it more difficult to get good returns on their money. Just think of how much interest, if any, you get on your bank account; it may add up to as little as few lattes a year.
"This prolonged environment of low rates is really driving people into risky investments, the stock market being the best example," says Tom Smythe, professor of finance at Florida Gulf Coast University, "and I'm not sure people truly understand it."
Then there's all the federal pandemic stimulus money that has sent immense amounts of cash into the world. Investors put much of it into stocks, causing share prices to rise.
"We've seen personal income rise and people have invested some of their checks as well," says Kelly Welch, vice president and wealth advisor at Girard Advisory Services in King of Prussia, Pa. Large institutional investors have also benefited and put more into the market.
A third point is that investors value stocks based on the future profits and cash they expect companies to generate. The effectiveness of vaccines, combined with the anticipation of a return to more normal economic times, puts an optimistic face on markets.
"Right now, there is a widespread expectation that vaccinations are going to lead to economic re-openings and, in many sectors of the economy, a rapid snap back to normalcy," McBride says. "In that context, investors see corporate profits looking a lot better than they did in 2020 when large sectors of the economy were shuttered."
Some steps to savvy investing
All this raises the question: How can the average person invest in stocks more effectively right now? The answer comes down to strategy, persistence—and benign neglect.
1. Be patient.
"For most investors, identifying and responding to what's going on in the markets today is not a good investment behavior," Goodwin explains. "Most people are investing because they want to meet a goal on some timeline. Goals are what define the investment plan."
Whether the goal is paying for a child's education, purchasing a house, ensuring a comfortable retirement, or something else, it includes a final amount and a timeframe to get it. "For most investors, that takes place in terms of quarters and years or even decades, not in terms of weeks and months," Goodwin adds. "Really staying anchored on those investment goals and the timelines to meet those investment goals is the main thing. I frequently have to take a step back, remember why I'm investing, what I'm investing for, and make decisions on a retirement that is decades away."
2. Look for help—and diversify.
Talk to a financial advisor who knows about investing. Also, certain types of investments offer build-in assistance.
"If you're stepping into this and I don't want to do a lot of research, an index fund is going to be your best choice vis a vis a mutual fund or something like that," says Elizabeth Edwards, managing partner of H Venture Partners. "The fees are very low; it's easy to access."
And a good index fund provides something key for investors: diversity. Funds that try to mirror an index like the S&P 500 pull in a broad range of stocks.
"Sometimes, some companies and industries do well, sometimes others do better," Welch says. So don't put all your eggs in one basket.
3. Stay consistent.
Look at your budget, determine (possibly with the help of a financial planner) how much you need to invest and what you can afford to, and then regularly put money into that account. And don't panic, even when things look like they've gone bad.
"Within a year, the stock market always goes down and always goes up," stresses Welch. "Don't be surprised by it, and don't be reactive to it. Pulling the ripcord only hurts you in the long run."
Keep the money in, and you'll be surprised how your nest egg grows over time.