While macroeconomic outcomes remain extremely uncertain in 2022, investors fear investing in stocks and have viciously sold through the first half of 2022. Whether it is from reading fear-mongering headlines or watching portfolios drop 50%+, the emotion of fear is driving markets right now, just as greed was driving the markets in 2021. Whether it’s a famous investor you follow, articles you read, conversations with your friends and family, a Youtuber, or a podcast host, there are many who have their theories on why we are headed for financial Armageddon and why you shouldn’t own stocks. Unfortunately, many retail investors were wiped out within the past few months and have a bad taste in their mouths, unlikely to invest in stocks anytime in the near future. The same “investors” who were hyping up specific stocks, preaching about their massive future opportunities, and buying at historically high valuations just a year ago (2021) are now running for the exits.
However, for long-term investors and those able/willing to stomach volatility, opportunities like this are quite rare. Some of the highest quality companies have come down significantly, mainly due to macroeconomic concerns. Long-term investors should be alert, prepared, and willing to invest in uncertain times as these are when bargains arise. The stock market is a wealth creating machine that compounds returns for patient investors over time. Trying to time the market, especially for non-professional investors, is a fool’s errand in my opinion (managing risk is a whole different story however). Instead, investors should always be searching for opportunities. Below, I’ll be discussing some general points about putting money into stocks (especially during a bear market), the current opportunities and risks in specific sectors, and how to practically put money to work without fear.
General Tips on Building a Long-Term Stock Portfolio
Before going on, please read this article which heavily relates to why long-term investors should ignore short-term noise and fear mongering, but rather focus on opportunities to build their portfolios. Price action (stocks moving up and down) should generally not be the reason why you sell or buy a stock unless you’re a short-term trader; put more simply, you shouldn’t panic sell a stock because you see it going down. Rather, by doing research on individual companies and gaining experience in how the stock market works, investors can gain the confidence to buy their favorite companies the cheaper they get. It is crucial to keep in mind that there is a lot more to it than how I phrase it, such as managing risk, trimming positions, hedging, doing fundamental research, looking at valuations, determining the individual’s risk profile/age, etc. But for many who don’t want/have the time to spend reading and learning in depth, buying and holding is generally the best strategy (and using declines as an opportunity to add to high quality companies).
Please Don’t Buy High Sell Low
One big mistake stock investors make is pulling money out (selling) after large declines and putting money to work (buying) after really good times. This leads to buying at higher valuations and selling at lower ones. This should be the opposite, but emotion and fear get in the way of logical investing. As easy as I make it sound, it is much harder in practice. It is extremely tough watching your portfolio freefall in a bear market, losing months or years worth of gains in a short period of time. Investors start to doubt their convictions, question the long-term prospects of the stock market, and promise never to invest in stocks again. In the coming weeks or months, they probably feel good about themselves as the market probably continues its trend lower. Those that were never invested in stocks in the first place feel a sense of pride and satisfaction that they avoided the carnage and the risky nature of the stock market. However, the former will likely regret selling out of the market in the years to come as markets recover and will forego a lifetime of compounded returns. The latter group has already missed out on years or decades of returns that they ignore and celebrate that they avoided a few months of losses. Both groups alienate themselves from an asset class which has generated enormous amounts of wealth over the decades for patient, responsible, and well-informed investors. Stocks tend to move irrationally and inefficiently in the short term, but more efficiently and fundamentally driven in the long-term. Use this to your advantage by setting emotions aside and using others’ fear/greed driven decisions as your opportunities.
Don’t Sell Solely Because of Price Action
I’m sure many people have the following thoughts: i) why they should buy stocks if they’ve been going down so much recently, Ii) stocks must be falling for a legitimate reason, right? Iii) markets are efficient so the majority can’t be wrong, iv) this particular stock must be terrible because it’s falling more than everything else, etc. The short answer to these questions is that how stocks move in the short to medium term, aka price action, is driven by short-term speculators, technical traders, hedge funds, and other money managers whose compensation system is tied to short-term performance metrics. Surprisingly, the market is pretty inefficient when it comes to pricing in long-term prospects. Instead, stocks move according to headline news and how short-term sentiment is. While certain types of professionals (mentioned above) can make money by following these short-term momentum/sentiment-based trades, fundamental long-term investors can find great value and mispriced securities. Even specific stocks or sectors are largely driven by short-term sentiment and traders. Digging into the fundamentals and doing some research will reveal long-term opportunities for patient investors. For those who don’t want to spend the time digging into individual companies, buying index funds is also a perfectly fine method of building long-term wealth. After all, the S&P 500 has not failed investors whose time horizon is many years or decades, even if they experienced short-term pain many times.
Whether in a bull or bear market, professional money managers look to make profits based on momentum and trend of the market. This causes exaggerated movements in stock prices that goes beyond the actual change in fundamental value caused by the changes in macroeconomic circumstances. In bear markets, money managers short whichever group of stocks is hated in that period of time and use each other’s momentum to profit. For example, money managers have for the most part recently shorted high-growth stocks and gone long oil/defensive sectors. This provided them with short-term profits to show their investors. However, this does NOT mean that the fundamental value (however you do your analysis – DCF, multiple etc.) has changed by nearly as much as the stock prices have. Who knows, towards the end of 2022 and into 2023, money managers could short oil, commodities, and other cyclicals because of headlines of impending recession and slowing inflation, and instead go long growth stocks which perform better than cyclicals in recessionary environments. Moral of the story, if you are not a pro Wall Street trader, you should probably stick to long-term investing and use these exaggerated price movements as buying opportunities rather than reasons to fear the market. When sentiment shifts, it shifts FAST and you could miss the start of the next bull run by remaining on the sidelines. It’s not worth trying to time markets and the economy – find enticing risk-reward investments and put some money to work when others don’t want to. In the long-term, stock values tend to gravitate towards a valuation more consistent with its fundamentals, rewarding those who use artificially deflated valuations to buy.
Don’t Try to Time The Market– No One is Smart Enough
Trying to time markets is a fool’s errand. An overvalued market can continue to climb higher for months, years, or more. An undervalued or oversold market can remain depressed for years. Each can also turn the corner viciously and quickly. The most successful investors have not made money timing markets, but rather consistently buying good companies and taking advantage of weakness. The effort and risk of missing out on the next leg up is not worth the useless hassle of trying to time when to get in and out of markets (of course, trimming positions into strength or hedging is a prudent risk management measure – this discussion is for people who make drastic changes to their portfolio trying to speculate how the market will move in the next few weeks or months). For ordinary investors looking to build wealth and a retirement fund, trying to be nimble by shorting/hedging, etc. is not feasible, so just stay invested and manage risk by trimming profits when appropriate.
It’s funny that investors like buying a stock at $200 because it’s gone up from 150 to 200 in the past few months and looks like a “strong stock.” However, if it falls from 200 to 100, they will hesitate to buy more or they will panic sell even though the company’s long-term thesis has not changed. If you really like the fundamentals of the company and buy it at $200, you should like it at 150 and be salivating to buy it at $100 given that the long-term prospects of the company have not changed. However, investors behave differently. Out of fear or unwillingness to suffer further losses, they sell at 100 hoping to get back in at 80. Then the stock might rebound to 120 and they’ll panic buy – then it’ll get clobbered back down to 100 where they’ll sell again for a loss. Eventually, they’ll probably miss the climb back to 200. Trying to sell in and out of positions will cause investors to miss out on large rallies – historically, missing just a few of the best days in the stock market has had detrimental effects on long-term portfolio performance. It’s not worth trying to act like a stock market genius selling in and out of stocks. Instead, investors with a time horizon in years should invest the amount of money in stocks they are comfortable with setting aside, stomach the volatility that accompanies the stock market, and add to their portfolio when the market presents more compelling prices.
Being greedy when others are fearful and fearful when others are greedy truly has merit and is how long-term wealth is built in the stock market. Buying near peaks (like in 2021) and selling near the lows is not a sound investing strategy, but rather one driven by emotion. Gaining the confidence to invest in bear markets comes slowly through experience, education, and mistakes.
Don’t Be an Economist – Use Macro Declines to Find Opportunities
Trying to invest based on economic predictions or what the Fed will do is not a sound long-term investing strategy. So called ‘experts’ and people on CNBC just fill the headlines with chatter. Many studies have shown that even the top economic experts are terrible at predicting macroeconomic outcomes – as Buffet once said, economists spend their life studying economics, yet there isn’t one super-wealthy economist. There will always be those who say this time is different and a big crash is coming/bear market for years, but in the end, macro outcomes are unpredictable and usually resolve themselves over the years, rendering any fear mongering incorrect and useless. Heck, just a year ago most 'experts' thought the Fed wouldn’t raise rates until end of 2023, inflation was transitory, and that a booming economic recovery would last for years. Instead of trying to be an economist, be an investor and buy good companies at reasonable valuations through thick and thin. Worst case, buy some index funds and call it a day, adding some of your income to it over time. It’s unlikely you will regret it 5, 10, or 20 years down the line. Use lower prices as entry points instead of a cry for the exits.
Current Stock Market and Specific Sectors
An important clarification before moving on is what the term “stock market” actually entails. Usually, when people refer to the stock market moving by a certain %, they are referring to the S&P 500, which is a market cap weighted index of 500 of the largest U.S. companies (with some nuance). 5 of the largest tech stocks (AAPL, MSFT, AMZN, GOOG, TSLA) make up 20% of the S&P – since megacap tech stocks generally move together, investing in the S&P naturally gives you a lot of exposure to megacap tech. Apple has been the savior of the indices given that its the largest market cap company - it refuses to give in on the valuation, still trading at 26x earnings as investors flock to it as a supposed flight to safety. The Nasdaq 100 is even more dominated by big tech, with the top 5 listed above making up 43% of the index. Thus, when you hear news about the stock market being down, it generally refers to one of these indices that is dominated by large cap tech. Even though the S&P has only fallen about 20% and Nasdaq about 30%, many companies beneath the surface have been absolutely obliterated with declines of 50%+. This point is something to keep in mind when discussing specific sectors, as that is where specific opportunities start to bifurcate from the overall market and offer investors value.
As far as the S&P itself, it’s trading at roughly 17x earnings, well below the average of the past 10 years. This is understandable given the rise in rates and has room for further compression if macro conditions continue to deteriorate. For stock pickers, this isn’t a particularly crucial number and should only be one factor when deciding to invest. For larger money managers with multiple asset classes, the S&P 500’s PE ratio might matter more when deciding how to allocate than for ordinary investors like me and you.
Hatred of Technology and Growth
In the middle of 2022, growth and tech stocks are the least favorite sector, many of them down 50%+ year-to-date. The high-growth darlings of 2020 and 2021 have given up most of their post-COVID gains, if not all. Megacap tech has also declined meaningfully, with companies such as META dropping 60% from its highs. Technology stocks have experienced probably the worst sell-off ever, even worse than 2000. Although the Nasdaq index fell a lot more in 2000, that was because of the composition of the index, which was more reflective of the current ARKK index with unprofitable tech companies. The Nasdaq index today is much higher quality and full of the most profitable companies in the world, making it less susceptible to large declines. Anyway, the point is that technology and growth stocks are trading at all time low multiples, with some being priced as cyclical, no-growth value stocks. For example, GOOG has historically traded in between 25-30 PE and is now at 18; META has also traded at 25-30 PE over the last few years, but is only at 12 now; CRM’s revenue multiple has fallen from an average of 8-9 to 5x. The list goes on and on, especially for small and mid-cap tech companies. The tech selloff is primarily driven by the rise in interest rates, which has a larger effect on longer duration assets (aka, stocks whose cash flow is further in the future as opposed to now because of current investments in growth). It is also exacerbated by how overweight/over-leveraged money managers and retail investors were in tech/growth in 2021. The Fed-induced decline in growth stocks caused margin calls and forced selling in concentrated investors. Bottom line, technology and growth stocks have never been as hated as they are now. An investor’s job in this environment is to find growth companies at attractive valuations with a strong business, ignoring the short-term negativity.
Love for Defensives
While most growth and technology stocks have reached all time low multiples, pricing in a high level of pessimism, so-called inflation hedges or recession-proof/defensive stocks have outperformed and reached all-time high multiples all within a year. For example, healthcare companies are considered resilient to economic conditions; thus, in economically uncertain times, investors flock to healthcare stocks as a flight to safety, pushing up multiples. For example, United Healthcare is trading at 26 PE, significantly above its historical average (high teens in the last few years). Additionally, consumer staples like Procter & Gamble, Costco, and General Mills are also trading at all-time high multiples as these essential products (food, paper towel, detergent, etc.) are seen as resilient to economic downturns. Thus, investors are paying very high multiples (relatively speaking) to own these low-growth companies because they are more likely to preserve earnings power in a recession. Oil companies have also clearly outperformed because of the rise in oil prices, but are starting to show some weakness towards the second half of 2022 as commodities generally plummet during recessions. For obvious reasons, oil prices are influenced by other factors as well.
Be Wary of Crowded Sectors
So why is it important to look at the relative performance of different sectors? First, it shows how short-sighted markets are and how they are driven by fear. Money managers have flocked to these inflation/recession-proof defensive stocks because of macroeconomic headlines. While this makes sense in theory, investing in stocks is a long-term game. Buying low growth companies at historically high valuations is not generally prudent – it seems logical now because of how “uninvestable” technology and cyclical companies have gotten. However, once this intense risk-off strategy cools off and investors come out of their hole of fear, these “safe” stocks could be the next wave of unfavored stocks.
Second, the outperformance of defensive sectors and their inflated valuation multiples (compared to depressed valuation multiples for growth), dispels one of the fears Wall Street keeps preaching. Some doomsday preachers say that stocks have not priced in a recession and that we’ve only seen the valuation compression that accompanies high rates. They think the market is too optimistic about EPS (earnings/share) estimates in the 2nd half of 2022 and 2023. However, the disparity between defensive and growth/cyclical multiples says that investors are willing to pay higher multiples for more stable earnings because they fear a recession and a decline in earnings for every other sector. If only valuation multiple cuts had taken place because of higher rates (and not EPS cuts priced in), defensive sectors would not be trading at near all-time high multiples. Despite higher rates, the multiples have risen for defensive sectors because of the higher “value” investors place on economically resilient earnings. On the flip side, investors have viciously sold off growth, technology, and cyclical stocks, (these stocks can be grouped together as “risk-on” stocks) depressing valuations to low levels in fear of declining earnings and lower top-line growth. That is why it is silly to me when “experts” keep saying that not enough downside is priced in and that defensive sectors are the best place to be. The risk-reward opportunity continues to improve as valuations in high quality risk-on companies continue to fall, with “smart money” crowding towards defensive sectors with little to no growth.
Third, the outperformance of these defensive sectors props up the S&P 500, masking a lot of the carnage to many sectors and companies that have been demolished. The S&P 500 is a market-cap weighted index, so as valuations of technology stocks fall, outperformance of healthcare and energy diversify away some of the pain (diversification is a whole different topic with much to dissect). Moral of the story, don’t chase these crowded defensive sectors because of fear and manipulative headlines. Think back just a year ago when it seemed like a great idea to chase high growth and technology companies because of ‘expert’ predictions that we’d have low rates for years and massive liquidity.
Potential Catalysts for Technology/Growth Companies
As inflation slows and rates fall/stabilize (whenever that may be), technology stocks should start outperforming. A drop in long-term yields is positive for growth companies whose earnings will come in the future (this is due to how DCF analysis works). A drop in rates should boost the valuation multiples of these tech companies that have been slaughtered due to the relentless rise in yields in 2022. In my opinion, a lot of the air has been let out of these once highly-valued growth companies and a significant amount of ‘bad’ has been priced in.
Another characteristic of many growth companies that have recently been clobbered is that they are secular growth stories, meaning that their performance is not as tied to the broad economy as cyclical companies. This is especially true for recurring revenue software companies that make money from contractual subscriptions. For example, Microsoft or Salesforce will have more stable earnings and will see their business less impacted in a recession than banks, luxury retailers, and industrials. However, even though markets currently fear a recession, companies with secular growth stories have seen their valuations significantly compress due to the unique nature of our current macroeconomic backdrop (rising rates and fear of recession). Usually, long-term treasury rates drop as recession fears worsen because of a flight to safety. However, given the current inflationary period, investors have shown no interest in growth stories (yet). If we enter a significant recession, inflationary pressures will almost certainly reverse course, likely sending long-term yields plummeting. This could add a significant tailwind and make quality growth companies more attractive again, as parking money in other sectors would not offer an enticing risk-reward dynamic. Sometimes, even if you had a crystal ball and knew that bad stuff was coming, it could still be prudent to buy certain stocks depending on how much bad news has already been priced in. This is, of course, much more difficult in practice, but is when the best opportunities arise in the market.
Even with technology/growth companies more sensitive to macroeconomic conditions like Google (advertising), buying companies such as these at depressed valuations can offer enticing long term compounded returns if their fundamentals still look promising over the long term. Economic cycles come and go – generally, the best time to invest in the companies of the future have been in bear markets. It’s just so hard to stomach the volatility and buy falling knives. If you had quality companies you loved a year ago and were buying near its all-time highs because of your conviction about its future, it would be imprudent not to buy now with the stock down 50%+ if your conviction has not changed. (As a side note, fundamental risks could have changed for a lot of companies in the past year because of how much more costly it is now to raise money).
The current market environment with rising/higher interest rates and decreasing liquidity has caused high growth stocks, especially unprofitable ones, to be absolutely crushed. Many of these growth companies relied on low interest rates and high stock prices to raise money to continue to fund growth and pay employees. Now that raising capital to fund growth has become prohibitively expensive, many growth and technology companies have been forced to pivot their focus on efficiency, profitability, and cutting costs (the past decade has mostly been focused on top-line growth). While these seem like desperate measures signaling only bad things to come, many of these technology companies' business models are actually not reliant on high overhead or fixed costs. I believe many of these technology companies, especially software companies, can reduce a significant amount of costs without sacrificing a significant amount of future growth potential. The primary cost for these companies is labor. In the past decade, these technology companies were rewarded by Wall Street for focusing on top-line revenue growth as opposed to profitability. This led to high stock prices, allowing companies to pay their employees in stock with minimal dilutive effects (see Glossary for explanation) - this is why many technology companies are overstaffed and were not incentivized to cut costs for the past several years. Although layoffs are obviously an unfortunate circumstances, it is an inevitable outcome in this massive technology stock sell-off. The companies that are able to adapt, take advantage of the lean business model inherent in many technology companies, and shift their focus to profitability will likely come out of this bear market stronger than ever. They will be ready to grow with the next economic cycle with a much leaner organization in place and much more money dropping to the bottom line. Unfortunately, some unprofitable companies that are cash flow negative will likely not make it or will have to significantly dilute shareholders to overcome this brutal market and economic slowdown. In my opinion, the winners will actually benefit from this pain and shareholders in these surviving technology companies will be rewarded for the insane volatility they endured. Weaker competitors with weaker balance sheets will pave way for the stronger ones. As far as who the winners will be, the metrics to watch for are companies with a large % of their revenues being recurring, high gross margins, positive free-cash-flow, or ideally, already profitable companies on a net profit basis.
In conclusion, once long-term yields give in and deep recession fears subside/are not realized, pummeled technology stocks that have been forever considered the highest of quality should receive a boost. If earnings/revenue growth picks up in a year or two from now, the next bull market for 'growth' stocks could gain serious ground. If you haven’t read my first article, I’d like to note that a year ago I was as bearish as one could get for growth/technology stocks because of their extremely high valuations and the impending inflationary/interest-rate risks. As overvalued as I saw technology stocks a year ago, the valuations have given in so much that I can characterize many of them as undervalued. One year can make a huge difference, whether it is to the upside or downside. Don’t try to time markets and the bottom, because you will stay on the sidelines until it is too late. Take the dip, manage risk, and buy great companies at good prices. Long-term opportunity is flooded out there right now, opportunities that are rare and only arise in scary environments.
Other sectors:
Banks: In the current environment with higher rates, banks generally tend to do better given higher net interest income (the spread between what they pay on deposits and what they earn through investments widens). As long as credit quality remains as strong as it is now (big banks have indicated there has been no deterioration in credit so far) and we avoid a deep recession, banks should do OK. Most large banks have strong balance sheets and are prepared to weather a recession. They also have been buying back stock for the past few quarters and will continue to do so once macroeconomic conditions become more certain. Banks pay modestly high dividends of 3-4%, but if you are purely looking for yield, treasuries give you the same yield at 0 risk of losing your capital. If the Fed induces a significant recession, then history says bank stocks will not perform well (treasury yields will likely fall at that point too, decreasing their net interest income).
Recent SPACs: Most of the recent SPACs can be grouped into the very broad category of growth, but I would be more cautious of these recent IPOs. These companies came public at peak demand, many of them which shouldn’t have come public in the first place. Additionally, SPACs have compensation structures in place which harm long-term shareholders. You can read more about it in my law school paper here.
Oil: Oil stocks (CVX, XOM etc.) generally move in tandem with oil prices. In the past year, these have soared to near-record levels given the relentless rise in gas prices. They have been a so-called good “inflation hedge.” But as the Fed tightens and the economy weakens, oil prices tend to fall, causing oil stocks to underperform as well. As of now, oil companies are printing money, paying out dividends, and buying back stock. These are all characteristics that investors look for in today’s market environment. However, given oil stocks are sensitive to macroeconomic conditions (and now, geopolitics), its unpredictable where they’ll head given their already-historic bull run in the past year. Oil stocks can be a prudent part of a diversified portfolio for large sums of money. If oil prices go up, these stocks will perform well. If they drop, inflationary pressures will subside and the Fed will have more leeway to back off, helping other sectors. For younger investors and smaller account sizes, oil stocks, especially at these prices, are not really going to move the needle as their upside is small at this point relative to the potential downside if oil prices fall. These stocks belong for dividend seekers and those seeking asset-class diversification (exposure to commodities).
How to Take Action
Every individual has their own risk tolerance and goals when investing. That is why general advice is meant just as a guide and not a prescriptive set of rules. People’s income levels, income stability, portfolio setup, personal expenses, and many other factors influence how they should deploy capital in investments. Therefore, before putting any money to work, assess the risks you take and your ability to bear losses.
Right now, there is a great opportunity for retirees and really wealthy/cash-rich people to lock in 4%+ yields on treasuries or even more on corporate bonds. 30-year treasuries yield the highest in a decade and the 10-year is at its highest since 2007. These are risk-free and essentially guarantee the 4%+ yield. Additionally, the interest income earned on treasuries is exempt from state taxation, which is particularly attractive for people living in high income tax states such as CA and NY (so in CA, a 4% treasury yield is essentially equivalent to a 4.5% yield). Inflation will likely return to the Fed’s 2% target rate within the next year or two – therefore, locking in 4%+ rates will get you a real return of 2%, if not more, for many years. If yields fall due to deflation/lower inflation, bond prices will rise (as yields fall) and you will be able to sell the treasuries for a profit as well. Again, this is a diversification/income strategy for wealthy individuals looking for conservative and steady returns.
As for younger individuals with less capital to invest and ability to undertake more risk given that they don’t need to prepare for retirement anytime soon (and perhaps no family to take care of yet), a longer time horizon and ability to stomach volatility plays to their advantage. For those that don’t need money immediately and can tolerate some risk, 2022 has presented a rare opportunity to buy quality companies as core holdings of a portfolio. It has also presented an opportunity to put some money to work in more speculative companies given their enormous declines. Some of these speculative plays will be busts but others will be huge winners down the line. Sprinkling some of your capital in these speculative names is perfectly fine, especially if your risk tolerance is higher.
Another aspect about stocks that is often overlooked are the tax advantages available to investors. This isn’t tax advice as everyone’s situation varies, but rather general principles to keep in mind. Taxes matter, especially for higher income individuals in higher tax brackets. First, gains from the sale of stocks (like other capital assets like real estate) are taxed at preferential long-term capital rates (20% for highest bracket) if you hold for a year. This is the most well-known advantage, but most definitely not the only one. Second, if you let your winners ride and you don’t sell, you don’t have to pay a penny in taxes (this is assuming the current administration does not pass its highly questionable bill to tax unrealized gains). For example, if you buy $100k worth of Apple and it goes to $10m in 10 years, you owe 0 in taxes if you have not sold. This allows your capital to compound without the impediment of taxes. If you sold/rebought in between the $100k to $10m gain once or many times, you would likely not end up with the full $10m at the end unless you’re a magical market timer. Third, you can use losses in a stock to offset gains in another (be careful of wash-sales). Sophisticated investors use tax-loss harvesting as a consistent strategy to increase total returns. Fourth, qualified dividends are available to those who hold dividend-paying stocks for a certain period of time (for simplicity, assume 60 days). This is important for retirees who need income. The cash paid to them from dividends will be taxed at long-term capital gains rates as opposed to ordinary income. For top-tax bracket individuals, this would be a 20% federal tax as opposed to 37.5%, a huge advantage. Fifth, stocks and other capital assets have a significant benefit when passing to your heirs upon death. These assets will receive a full step-up in basis upon death, meaning that any capital gains on those stocks will never be taxed (there may still be estate taxes obviously). For example, if you buy $100k in stocks and it’s worth $10m when you die, your children will receive the stocks with a basis of $10m, meaning if they sell for $10m, they will pay no taxes. However, if you sold during your lifetime for $10m, you would owe taxes on $9.9m ($10m-100k), which would roughly be $3.4m for top tax bracket individuals living in California. That would only leave $6.6m to your heirs instead of $10m. To sum up, there are real advantages in stocks due to tax law. The tax law favors holding. Therefore, long-term investors who don’t constantly try to trade in and out of stocks end up with real performance boosts. Of course, there is much more nuance to this such as options strategies that can be used to protect gains while also avoiding taxes, or retirement accounts that are tax-deferred. For now, just know that stocks have multiple tax advantages that make a significant difference on returns over time if properly accounted for.
Some time-tested and cliché ‘strategies are listed below which investors should carefully consider before making investing decisions.
· When it comes time to buy, you won’t want to (aka, you will be fearful of falling prices).
· Slowly put your capital to work and don’t fully buy into a position at the start. If you like a stock, buy some and leave room to add if it drops.
· Be patient – the market takes money from the impatient and transfers it to the patient.
· If you are buying individual stocks (as opposed to ETFs/index funds), know enough about the company so that you have the confidence to hold if the price drops. The time to sell comes when your fundamental view on the company changes. The time to sell is not when it drops 30% because of macroeconomic concerns or a broad market pullback. That is the time to consider adding.
· It really doesn’t take an expert or genius to make money in the stock market. Everyone can learn the basics in a few weeks which is all you need. Don’t be scared to dive in.
· Don’t overextend yourself or borrow to invest in stocks. Put money there that you don’t need to survive.
· Diversification works but it can also work against you. This is a more complex and in-depth topic for another time. Don't dwell over it.
There’s a lot more to say, but in the end, you learn the most from experience. If you are not confident/comfortable enough yet, start small and gain the confidence to invest larger sums of money in stocks. You will make mistakes and you will lose money. It’s part of the process and part of the price you pay for long-term returns. There will always be people who lost money in the stock market or who were told by people who lost money in a start market that it’s a rigged system and that it’s too risky. Even if both are true, that doesn’t mean there aren’t opportunities for patient investors to build wealth. The stock market is a way to invest in the most successful businesses in the world and the best CEOs/founders. There is an actual business behind the stock (at least for most of them lol) – stocks are not merely gambling mechanisms, although some may treat them as much. The earlier you start, the more time you have to compound returns, the more time you have to learn, and the younger you can make mistakes so that you don’t make those same mistakes later on when it is of more consequence. With the right temperament, risk management, some research, and a bit of luck, you likely won’t regret allocating a part of your net worth in stocks 10 or 20 years down the line.
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