Three traps to avoid for young investors
Investing today is quite easy. However, it’s crucial to have some basic ideas clear before starting. We’ve all heard about the common mistakes when it comes to investing: lack of diversification, chasing returns at any cost, ignoring commissions, among others. But in the current context, it’s worth examining three traps that young investors should avoid if they aim for some future peace of mind.
A few weeks ago, The Economist pointed out in an article that young investors haven’t been too lucky so far. The ‘golden era of investors’ spanning the four decades before 2021 allowed their parents to achieve unusually high returns, with an average annual return of over 7%. However, the financial outlook for those under 40 today is much less promising.
The year 2022 was particularly bad for investments. For instance, the S&P 500 dropped by 21% in just the first half of the year, marking the worst first semester since 1970. By the year’s end, it closed at -19%. Even the typical 60/40 investment funds experienced a 17% drop that year, a situation only surpassed in 1931 and 1937. Bonds and cryptocurrencies also faced tough times. Inflation, rising interest rates, and the war in Ukraine are among the primary culprits for this debacle.
The year 2023 has shown a remarkable improvement. According to BlackRock, by the end of November, US stocks had accumulated an annual gain of almost 21%. This happens at a time when, thanks to high interest rates, safe options like bonds have hovered around 5% annually. However, the boon of the last forty years presents various traps for young investors, according to The Economist.
Accumulating too much cash
Despite 2022 being an adverse year for equities, obsessing over cash and ‘risk-free’ investments isn’t a good option. The article mentions that US Treasury bonds have yielded only an annual return of 0.4% since 1900. Stocks provide much greater value if, as recommended by Urbanitae, a long-term investment strategy is adopted.
Avoiding fixed income
The second trap is the opposite. The Economist indicates that bonds represent approximately 5% of the investment portfolio of Generation Z members, born in the mid to late 1990s. On the other hand, for ‘baby boomers,’ those born in the 1940s, 50s, and 60s, the proportion of bonds averages 20%.
Bonds should have a place in a diversified and balanced investment portfolio, especially considering their ability to resist inflation better than cash.
Thematic or niche investing is not new, and its disadvantages are well known. Those exclusively betting on investments related to a specific theme, such as ESG funds, often face higher volatility and, frequently, higher fees. Additionally, sometimes the difference is minimal: a Harvard Business School study noted that 68% of the ESG fund portfolio was identical to that of traditional funds. The Economist warns that trends change, and even those choosing reasonable themes are competing in the market with professional managers.
In the end, keeping calm and following a solid long-term investment plan is the best way to avoid traps, both for young investors and those not so young. If you want to learn more keys to invest with peace of mind, you can check out our Learn section.