A word to the wise: Don’t be afraid to invest in stocks. This thought comes to mind after reading an article in CNN Money, Crisis Hangover: Millennials Are Afraid to Invest.
The economic chaos of 2008, which erupted during the formative years for many young Americans, inflicted scars on millennials that are shaping their investing decisions today and possibly hindering their future retirement prospects. Ninety-three percent of millennials say that both distrust of markets and lack of investing knowledge make them less confident about investing, according to a new Capital One ShareBuilder survey released exclusively to CNNMoney. A similar analysis by State Street found that millennials are also holding a significant chunk of their portfolio – 40% – in cash despite historically low interest rates. The findings suggest young Americans may not be getting the exposure to the stock market that has helped previous generations accumulate wealth.
The CNN article seems focused on how to make it easier for young investors to invest in stocks. While we agree with a don’t be afraid to invest in stocks thesis there is more to the story.
Deflationary Times when Cash Is King
A recurring economic theme since the 2008 market crash has been the risk of deflation. If deflation takes over an economy the results can be disastrous for anyone who is not holding on to a wad of cash. Investopedia defines deflation.
[Deflation is a] general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression. Central banks attempt to stop severe deflation, along with severe inflation, in an attempt to keep the excessive drop in prices to a minimum. Declining prices, if they persist, generally create a vicious spiral of negatives such as falling profits, closing factories, shrinking employment and incomes, and increasing defaults on loans by companies and individuals. To counter deflation, the Federal Reserve (the Fed) can use monetary policy to increase the money supply and deliberately induce rising prices, causing inflation. Rising prices provide an essential lubricant for any sustained recovery because businesses increase profits and take some of the depressive pressures off wages and debtors of every kind.
If millennials are concerned about deflation, holding forty percent of assets as cash may be a sign of a thoughtful investor and not of a confused one. But what should investors do about the long term and building up retirement savings?
Learning about Intrinsic Value
The benchmark for long term investing is to beat inflation by a few percent every year. Those few percent then compound annually. Add a little (or a lot) to your portfolio every year and watch those additions plus compounded gains grow to a healthy nest egg. The key to making this work is first of all not losing money. Secondly the key is to pick undervalued stocks that have the potential for long term growth. Here is where the concept of intrinsic value comes into play. John Huber wrote an article recently in Forbes about The Simple Concept of Intrinsic Value. He quotes Ben Graham who invented the concept.
“The newer approach to security analysis attempts to value a common stock independently of its market price. If the value found is substantially above or below the current price, the analyst concludes that the issue should be bought or disposed of. This independent value has a variety of names, the most familiar of which is “intrinsic value”.
He also quotes legendary investor, Warren Buffett, who was a student of Graham.
“Intrinsic value is an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.”
The point of this is, don’t be afraid to invest in stocks. Learn to analyze the fundamentals that drive prices and look for stocks with the prospect of a long term, increasing income stream. Then watch the always-inefficient market for opportunities. There are many times when negative investor sentiment drags down the price of a good company. That is the time to buy and hold and make money.