EmailThe pervasive pessimism regarding financial markets and global economies is fully understandable. It masks some potentially huge opportunities, however, particularly for young investors.
Housing
The housing market has been a disaster -- at least for those who own homes.
For those looking to buy their first home, or to step up to a more expensive home, however, current conditions are what might literally prove to be a once-in-a-lifetime opportunity.
The simple facts are that home prices are down significantly, and mortgage rates are extremely low. As a result, homes are more affordable than, well, almost ever.
The National Association of Realtors affordability index hit 190.8 in September. From the inception of the index in 1970 through 2007, the index ranged roughly between 150 and 70. (A higher level on the index means homes are more affordable.) Since 2008 it has rocketed higher as home prices have fallen and mortgage rates have eased.
(For recent data, please see this page. For a chart of 1970 through 2008 data, please scroll down on this page).
Home prices could ease further, but buying a home should not be done with short-term trading in mind. Trying to pick the bottom as a time to buy will seem silly 30 years from now for those in the same home.
In the stock market, everyone says "buy low, sell high." Yet, few have the courage to do that because when prices are low, fears are high. It is the same in the housing market. Fears that housing prices may fall further should not distract those who will own a home for years from the fact that now is a time when prices are certainly low.
This may well prove a unique opportunity for those considering either increasing their investment in housing or taking the first step towards home ownership.
The Stock Market
The same long-term opportunity exists for young people in the stock market.
More mature investors nearing retirement have seen their net worth hammered by lower home prices and the decline in the stock market from the highs of 2007.
The very real pain associated with the fact that stock prices are still lower than they were five years ago is what provokes the overwhelming negativism heard every day on TV and in the press.
That rear-view mirror approach is totally irrelevant to young investors, however, and even to the astute, mature investor.
The opportunity for long-term investments in high quality stocks is driven home to your author by his personal experience.
In January of 1990, I was awarded 100 shares of McGraw-Hill (MHP) stock for presumably managing a unit of the company in some way of benefit to shareholders. The 100 shares at the time were worth approximately $5,700. I chose to have my dividends re-invested into stock purchases. The dividend was $2.16 per share, providing a yield of 3.8%. At the time, the 30-year bond yield was approximately 8%.
McGraw-Hill was considered a relatively sleepy investment in those days, and attracted little attention as a publishing company. During the roaring 1990s the stock was virtually ignored, as focus was squarely on technology companies.
That $5,700 award from 21 years and eleven months ago is now worth $50,500 today.
That is a compound annual rate of return of approximately 10.5%.
This example happens to be based on a company that has performed well over the past two decades. That covers a ten-year period when the stock market rose sharply, followed by a ten-year period when the market was flat. It also does not include the impact of taxes due on the dividends re-invested (which can be eliminated for many by investing through 401k and similar plans).
Nevertheless, this provides an example of the long-term opportunities which may exist for young investors today.
There are numerous stocks of extremely high-quality companies which are at very low valuations that pay excellent dividends of 2% to 3% or more. Many of these stock prices have been essentially flat over the past ten years. Johnson & Johnson (JNJ) and Wal-Mart (WMT) are two examples (both of which your author owns). These companies are growing, boosted by international opportunities, and have raised dividends year after year.
Investing in these types of companies, possibly with the benefit of compounding by use of dividend re-investment, might just provide long-term returns similar to the example above. A "growing rich slowly" approach might be less appealing than seeking quick returns, but is often a more reliable way to build wealth.
To someone counting the years until retirement, a 21-year time horizon might be impractical. For a young investor in his twenties or early thirties, I can guarantee that the time will pass more quickly than you will imagine.
The current low valuation on stocks, as with the low prices in the housing market, may prove the opportunity of a lifetime for investors in this age bracket.
Volatility Can Be Your Friend
To many young investors, the recent volatility in the stock market can be frightening. It is often an excuse for avoiding the stock market. For the long term, however, the volatility can actually improve returns.
If an investor has few assets and starts putting money into a 401k plan every month to buy stocks, it doesn't really matter if the stock market goes down over the next few years.
In fact, that can provide a distinct benefit.
Every time the market dips, that investor is purchasing stock at a lower price. The decline in the currently held assets is less relevant because the holding relative to the continuing investment is small.
Take the example of someone beginning to invest in stocks via $100 a month in a 401k plan. If the market drops 10% the first month, egad!, the investment is now worth only $90. That 10% drop may be a disaster for a retired investor, but for the new investor it simply means the next $100 investment buys stocks at a cheaper price.
Every time the market drops or stays low, the continuing investment buys greater value.
All that ultimately matters is the level of the stock market when the investor wants to cash out or move money out of stocks into alternative investments.
The continuing investor actually ends up with far greater returns if the stock market stays down for an extended period and then rallies in later years, compared to the return if the stock market rises slowly and steadily to that same level over the same number of years.
To young investors with a long-term perspective, the current depressed level of the stock market may well prove a once-in-a-lifetime opportunity; and every market dip could well increase long-term returns.
What It All Means
The S&P 500 is up 42% over the past three years. It is up 13% over the past two years, and 2% over the past year.
That almost sounds like a bull market.
Yet, it unquestionably feels like a bear market.
This is because the discussion is dominated by those who have experienced a total decline in wealth over the past five years. It will take a number of years more before total wealth for many returns to previous levels. It is hard to be upbeat under those circumstances.
That is precisely one of the reasons young investors with few assets should look at current conditions as an opportunity. Now is a time to seriously consider investing for the long term.
Even for more mature investors, the reality of the rise in stock prices the past few years, and the prospect of further increases, cannot be ignored.
The only relevant question for an investment today is -- will the value go up or down in the future? It makes absolutely no difference what the value was previously.
The overwhelming pessimism swirling around political, economic, and financial market discussions today has raised fears and has depressed valuations in many asset classes.
These are the times when it is hardest to invest, and historically, the times when long-term opportunities have been the greatest.
