Recently I was at a women’s networking event and I overheard a few women say how glad they were to have switched their 401k investments to cash because they couldn’t bear to lose any more money due to the recent market volatility. These women were still in their 30′s or 40’s, with retirement a good 20 years plus away. Unfortunately for these ladies, having long term retirement money in cash is actually not the best idea, even with all the recent market volatility. It got me thinking, is this how most people invest their assets for the long run? By timing the market and trying to figure out the best time to sell out and switch to cash?
Market volatility is a normal occurrence when investing in the stock market, yet as much as you know it to be true, it can be tough to handle when it’s your own money at stake. Famous business tycoon (and billionaire) Warren Buffet says it best, “It won’t be the economy that will do in investors; it will be investors themselves.” History shows that markets go up and down, but you shouldn’t react to short term fluctuation, even the huge dips. I know you are thinking, “I’m still not ready to play fast and loose with my hard earned money!” However, historically the markets tend to rebound and reward those investors who stick it out and stay the course. And while no investment strategy ensures a profit, it’s good to keep in mind some helpful tips when investing for the long term.
Tip 1- Diversify, diversify, diversify.
Diversification is one of the key ways to handle market volatility. That’s because different asset classes (i.e. stocks, bonds, cash, real estate) often perform differently from one another, so spreading out your money between them all can potentially help reduce your overall risk. If one of your investments declines, another may perform well, balancing out your overall portfolio risk. Although diversification cannot eliminate total market risk, it helps smooth out the ride.
Tip 2- Don’t let your emotions get in the way.
This tip is easier said than done. Usually people react to market volatility by making emotional decisions; however, our emotions usually lead to irrational and impulsive decision making that can potentially compromise the long term performance of your investments. Uh oh. People tend to buy high and sell low (which is the exact opposite of what you want to do) because their emotions get in the way. Keep in mind that the media also loves to invoke fear and anxiety in its audience. It’s no secret that they tend to spin stories to get the best possible headlines. They have their best interests in mind; not yours
Before you decide to react to the market volatility, take a minute to review your financial plan and goals. If your goals have changed you may need to tweak your investment strategy. But if your financial situation is the same and your goals are the same, then you need to stay the course and ride the waves. Be strong!
Tip 3- Market timing doesn’t work.
During volatile markets you will be tempted to pull all your money out of the stock market and invest in lower risk investments, such as cash. Don’t do it! You have to remember those less volatile investments also have less return over time. They may seem like the better option when your investments are in the negative territory, but remember, it is taking on the negative returns that allows for a higher average return potential over time. Basically, more risk = more return potential. If investors were not rewarded for the extra risk they took on by not knowing what their return is going to be in any given year, then no one would invest in the stock market. Investors who stay the course have been historically rewarded for their patience, but many people, including the women I mentioned in the first paragraph, think they can shift their investments to and from stocks to cash, thereby avoiding market downturns. By trying to time the market like that, they often miss the market’s best returns. If timing the market were possible, every investor would be rich. Guessing when to get out and get back into the stock market is a game you don’t want to play.
You can see in the chart below that even missing the top 50 days in the stock market can dramatically affect your overall performance. *Keep in mind, past performance is no guarantee of future results.
Tip 4- Focus on dollar cost averaging.
Dollar cost averaging is one of the easiest investment strategies to implement. It’s simply deciding to invest a specific amount into the market at regular intervals over time. Most individuals do this within their 401k plans at work. For example, if you are placing 7% of your salary into your 401k, every month that 7% gets invested regardless of how high or low the stock market is. Over time dollar cost averaging helps you buy more shares when the stock price is low and less shares when the stock price is high, resulting in a lower average stock price over time. Sweet!
One little note on this tip: dollar cost averaging involves continuous investment in securities regardless of their fluctuation in price. As an investor you should consider your ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.
Tip 5 – Have faith in the future.
Nick Murray, one of the financial industry’s premier speakers and the author of eleven books for financial services professionals, makes it pretty simple when he says, “have faith in the future.” By this he means, when you are investing in the stock market, you have to have faith that even during the hard times, things will get better. He even created a mantra you can say daily as you grow as an investor: “I don’t know exactly how things will turn out all right; I just know that they will turn out all right.” I agree with this 100% because at the end of the day, you have to have faith that we will all continue to be resilient and find solutions to our problems, making the future—and our troubled economy-- better.
To recap, here are some common investment “no-no’s” to avoid:
Remember to work with your financial professional during these difficult times to ensure your short term and long term investments are in alignment with your financial goals, needs, and risk tolerance.