The stock market is a chaotic place. One day the market is hitting a new high, and the next, it’s in freefall. These constant ups and downs can make investing seem like that toxic relationship you had in high school you promised yourself you’d never repeat.
Sure, you had some great times, but the breakup was terrible! What if investing is the same way, and when you finally decide to call it quits, you have to cash out your investments when the markets down? Think about how quickly all of that money you worked so hard for that would vanish! Then what will you do? Sell your possessions, move in with friends or family, kiss the possibility of retiring goodbye, and find a job you think you can tolerate until the day you die? Talk about a nightmare.
If you’re scared of investing, you’ve probably played a scenario like this out in your head. But I have a question for you. Do you actually know anyone who lost all of their money investing in the stock market?
My guess is you don’t. And if virtually none of us know someone that lost it all investing in stocks, why are we so fearful of it? I’m going to answer that question by breaking down the psychology behind why stock market investing is so intimidating, tell you how to overcome your fear, and fill you in on the investing strategy that makes it almost impossible for you to lose money.
Why You’re Scared of Investing
The reason you’re so fearful of investing is because of a concept called loss aversion. This is when people do more to avoid a potential loss than they would do to acquire a potential gain. The reason we do this is because losses feel considerably worse to us than gains.
Imagine if your boss sat you down and gave you one compliment and one criticism. You would probably fixate more on the criticism than the compliment. If one person leaves you a positive comment on Instagram, and another person leaves you a negative one, you’ll probably feel more strongly about the negative comment than the positive one. It’s not that we don’t enjoy the positive part, it’s just that we dislike the negative part more. The same is true for money.
Take the popularity of the debt freedom movement, for example. People absolutely HATE the idea of “losing money” to interest, so they throw massive amounts of money toward their debt to pay it off asap. But how much does this actually save you?
Let’s say you take out a loan for a $250,000 house at a 3.5% interest rate for 30 years. If you pay an additional $1,000/month on your loan, you save almost $100,000 in interest and shorten your loan by 17 years! That’s an incredible savings, but what would have happened if you had invested that extra $1,000 instead?
Assuming you’ll receive the average return of 10% per year, investing $1,000/month in the S&P 500 for 13 years (the same amount of time it would have taken you to pay off your mortgage), would earn you almost $300,000! And since your extra $1,000 isn’t going toward your mortgage, it’ll take you the full 30 years to pay it off. While that sucks, the good news is that if you keep investing your extra $1,000 over those 30 years, you’ll earn over $1.9 MILLION!
So it’s a no-brainer. You’d take the $1.9 million in earnings over a savings of $100,000, right? Many people don’t. Even though they know they can earn 19X more money by investing, many people still choose to pay off their debt rather than invest. Why? Because of loss aversion and certainty.
You know with 100% certainty that if you pay an extra $1,000 toward your loan, you will pay it off early, and you will save money on interest. Investing is more abstract. While highly probable, the massive gains from investing are not certain. The fact that there is a possibility, however small, that you could lose money investing holds people back.
Now that you can see the massive potential investing has, how do you overcome your fear and start doing it?
If you think you need to have thousands of dollars saved before you can start investing, that couldn’t be further from the truth. You can start off investing $5 or by contributing 1% to your 401k. These ultra-low investment minimums have been made possible by the popularity of fractional shares.
What Are Fractional Shares?
Fractional shares are exactly what they sound like. They’re a fraction of a share of stock. Back in the old days, you could only buy an entire share of a company’s stock. This made buying stock in many large, well-known companies difficult for early investors because of their high share prices.
Here are some of the current (by current, I mean the day I wrote this post) share prices for some popular companies.
- Tesla – $670
- Chipotle – $1.444
- Google – $2,030
- Amazon – $3,110
- Berkshire Hathaway (Warren Buffett’s company) – $380,402
No, that isn’t a typo. To buy 1 share of Berkshire Hathaway costs almost $400,000! Few people have that kind of money to invest when they’re starting out, and that’s where fractional shares come in handy. If you only have $100 to invest, you can still invest in the companies listed above by buying the following fractions of a share.
- Tesla – 3/20
- Chipotle – 7/100
- Google – 1/20
- Amazon – 3/100
- Berkshire Hathaway – 3/10,000
Being able to buy fractional shares means you don’t need to save up thousands of dollars and then get anxious about putting a large lump sum of money into the market at once. Instead, you can invest small amounts of money at regular intervals, an investing method called dollar-cost averaging.
What Is Dollar-Cost Averaging?
Dollar-cost averaging is an investment strategy where an investor divides up the total amount they’re going to invest into multiple smaller purchases. The goal is to reduce the potential losses you could face if the market drops immediately after you invest a large sum of money. Here’s an example.
Let’s say you want to invest $10,000 this year. If you invest all of it today, and the market drops tomorrow, you’ll lose money on all $10,000. But, if instead, you use dollar-cost averaging and invest $833/month, you’ll only experience losses on the money you’ve invested up to that date. If it’s June, for example, you’ll have invested $5,000 of your $10,000, so only $5,000 will be negatively affected.
Even better is that when the market drops, shares of stock become cheaper. So now, when you invest your $833 next month, you’ll be able to buy more shares with the same amount of money. Later, when the market goes up, you’ll be able to recover your losses and make money on the shares you purchased at the lower price.
Another perk of dollar-cost averaging is that you can automate your stock buys, so you don’t have to constantly work to make investing a priority. Instead, you just set up automatic purchases, and everything happens behind the scenes. You don’t have to lift a finger.
To do this, open an investment account if you don’t already have one, select the amount you’re comfortable contributing, and determine how often you’ll make your contributions. Remember, $5/month is better than $0/month. You can always increase your contributions later as your comfort level increases. You’ve got a while to get comfortable, which brings me to my last point.
Invest for the Long Term
Long-term investing isn’t glamorous or thrilling like the investing you see in the movies or on the news, but it is a surefire way to make lots of money. According to a study by NerdWallet, a 25-year-old that invests 15% of their income into the S&P 500 for 40 years, has over a 99% chance of maintaining their initial investment. That means it’s almost guaranteed that you’ll at least get your money back. But the study went a little further.
It also showed that there’s a 95% chance that you’ll earn nearly 3X your initial investment! While this is just a simulation, if you look at the returns of the S&P 500 since its inception, you can see that they’ve gone waaaaay up.
If you had invested $100 in the S&P 500 in 1957, you would have over $50,000 today. That’s an incredible amount of money to make from such a small investment. So how can you do this?
Invest in a Diversified Fund
The key to great performance over the long term is investing in a diversified fund like an index fund, mutual fund, or ETF. Funds that track the S&P 500 are a great example of this. They hold all 500 companies that the S&P 500 index tracks, and when you buy one of these funds, you’re actually buying a fraction of a share of all 500 companies.
Remember the saying, “don’t put all of your eggs in one basket?” Well in investing terms, this can be translated to, “don’t put all of your money into one company.” If you do, and that company fails, you’ll lose all of your money. If instead, you invest in an S&P 500 index fund and own 500 different companies, if one fails, you still have 499 more that you can make money from.
Investing in so many different companies reduces your risk because your chances of losing money decrease dramatically. If the thought of losing money in the stock market is holding you back, investing in a diversified fund is the way to go.
Hold Your Investments for Decades
The second thing you need to do is to hold your investments for decades. In the NerdWallet simulation, the investors held their S&P 500 shares for 40 years, and in our debt vs investing example, the investor held their shares for 30 years. Once you buy the diversified fund, you need to let it do its thing for a long time before you can earn a substantial income.
Take a look back at the S&P 500 graph from earlier. You see how the line is almost flat before it jumps dramatically up? This is due to compounding, which provides exponential growth. You have to wait out the slow period to reap huge gains later on. After decades of investing, the extreme growth in your investments will make it near impossible to lose it all.
So while it’s totally normal to be anxious about investing in the stock market and want to avoid it, it’s also irrational. Even though there are peaks and valleys, it’s basically a guarantee that you’ll make money, and a lot of it, if you invest in the stock market. You just need to stick to investing in diversified funds, automate your investments, and let them grow for decades.