Investing

Young investors have gone from 'risk averse' to 'the opposite extreme,' expert says: Here's the better way

"Buy a plain vanilla index fund or maybe a target date mutual fund."

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Usama Ehsan, a 29-year-old based in Costa Mesa, California, was laid off from his accounting job in April 2020, when the Covid-19 pandemic sent the economy into a downward spiral. With his extra time at home, he began buying stocks.

"You start wanting to do things that you never had the time to do and you start wanting to take a risk," Ehsan says. "There's a certain amount of pleasure you get when you see an individual stock that you picked shoot up."

Ehsan is part of a surge in new retail investors focused mostly on individual stock-picking, which has caused "a lot of hand-wringing over whether young investors are actually taking too much risk in their portfolios," says Christine Benz, director of personal finance at Morningstar.

"Just a few years ago, the discussion was, well, 'These young investors have seen how their parents have struggled with investing in the market with home values. These young investors are so risk-averse,'" says Benz. "And now we're sort of at the opposite extreme."

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With more time on their hands amid Covid-19 lockdowns, a record number of retail investors, or nonprofessional investors managing their own money, began buying stocks. In 2020, retail investors were responsible for about 20% of the shares traded on the U.S. stock market, up from about 15% in 2019 and 10% in 2010, according to Bloomberg Intelligence.

Stock-picking paid off for many new investors last year, as the market rebounded from its March crash and soared to record high after record high.

That might have taught people the wrong lessons, says Benz: "There has been a lot in the past year that has really reinforced some investors' worst tendencies to gravitate to narrowly constructed portfolios, to chase performance."

There has been a lot in the past year that has really reinforced some investors' worst tendencies.
Christine Benz
director of personal finance, Morningstar

Experts are concerned that many retail investors are taking on too much risk with stock-picking and even day trading, which entails buying and selling stocks for short-term profits, as opposed to opting for safer investments like index funds, ETFs, or target-date funds, which are baskets of securities that reduce risk.

Ehsan is one of many focusing on individual stocks. "Right now I haven't learned how to diversify my risk yet," he says. "I don't know too much about index funds."

The risk of focusing too much on individual stocks is if a stock falls, an investor who isn't diversified could lose a lot of money. That's what happened to many investors when the dot-com bubble burst in 2000. And it's what just happened to a lot of retail investors who got excited about meme stocks like GameStop that surged in late January before falling again in February. On Monday, GameStop traded at $60 a share, down from a high of $483.

The 'better way to get started in investing'

"A better way to get started in investing is actually really boring," Benz says. "Buy a plain vanilla index fund or maybe a target date mutual fund. It's not a sexy message, but it's one that's been incredibly effective for a lot of investors for many years."

Experts generally recommend that beginning investors park the majority of their investing money in diversified assets like index funds, ETFs, or target-date funds. Then arrange to have a set amount of your money auto-transferred into those assets on a regular basis.

You could use 5%-10% of your portfolio to take more risk with individual stocks, but only once you've achieved other financial milestones like paying off debt and building an emergency savings fund, experts say, and you have some extra money to play with. This is, essentially, money you know you might and can afford to lose.

The market may have rewarded having fun with stock-picking in 2020, but going forward, experts say, it's much safer, and still rewarding, to take a boring approach to investing.

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