I strongly recommend investing in the stock market. Not all your savings, but a good chunk of your savings that you don’t plan on touching for at least 10 years. Simply, over the long term, the stock market returns far better yields than any other investments available to the average investor. Bonds will barely beat inflation, and bank interest rates often return less than the inflation rate, meaning that money sitting there is actually losing value (in terms of purchasing power).
Expect the Market to Rise and Fall, and Invest for the Long Haul
The stock market is volatile. Sometimes your investments will rocket up at unbelievable rates. But sometimes the value of your investments will drop. Sometimes that drop will be dramatic. When this happens, many investors get scared and pull their investments out of the market to try to prevent any further losses. If you are invested in the stock market, you might be tempted to do the same thing. Don’t! The stock market has always rebounded from these losses, usually surpassing the pre-crash level. As long as you stay invested, you will benefit from the rebound, putting your investments back on track.
Sometimes, however, this rebound doesn’t come for several years. This is why you only should invest for the long term. Only invest with money that you won’t need for at least 10 years. In the last big stock market crash, for example, the market started dropping in 2007. It kept dropping for over a year. Finally in 2009, the market started turning, but then didn’t fully recover from the crash for another several years. All told, if you had invested late in 2007, it would have taken about 6 years before your investment would have fully recovered from the crash.
You Only Lose When You Move
In the 07-09 crash, after a year of consistently dropping, many investors couldn’t handle it anymore and sold their investments. When they sold, they locked in their losses, and many completely missed the rebound. It’s easy to look back on past stock market crashes and tell yourself that you’ll be able to stay the course. You might even tell yourself that you’ll be able to time the market. It’s easy to say that if you had only been in the situation, you would have sold in early 2008, and then re-invested in early 2009. But we all know that hindsight is 20/20. In reality, every crash looks different from the last. Sometimes the market just dips a little bit and then rebounds. Sometimes its a slow slide down and a quick rebound. Timing the market is a fools game and ends up costing you in your overall return.
When the market starts tanking, and your portfolio value starts sinking, remember that these are all just numbers. They change from day-to-day. Your losses only become real when you make a move and sell. When you sell, you’ve locked those losses in. So when the market starts sinking, hold tight and try to enjoy the ride.
Dollar Cost Averaging
The best investment strategy is to have a set of rules that will guide when you buy and sell your investments. You have to commit to following these rules regardless of what the market is doing. Commit to investing a certain dollar amount or a certain percentage of your pay every month or every pay period. Investing on a regular basis like this is called dollar cost averaging. By spreading your investments out, you’re not exposing yourself to buying at precisely the wrong time.
Similarly, when the time has come for you to start moving out of the stock market, you want to do so gradually. Gradually start shifting out of stocks, and into more stable bonds. Re-balance your investments on a regular basis, decreasing the percentage of your investments in stocks by 3-5% every year. Re-balancing gradually guarantees that you won’t be selling all of your investments at market low points. You’ll have sold when the market is up, when the market is down, when the market is sideways and when the market is upside-down.
Two Times To Time
I have two exceptions to my no-timing rule. If the stock market has recently dropped significantly, and you have a bunch of extra cash lying around, this would be a good time to start investing it. You’d be buying stocks on a significant discount from the high prices that they’ve been at recently and would be getting a comparative bargain. Of course, for all you know, the market could continue to drop for some time, or it could start going back up, so you could choose to invest all at once, or invest in increments. Either way, when the market does rebound, you’ll see an even better return than if you had invested at the previous peak.
Secondly, if you are at the point where you are starting to think about selling your stock investments, or are part way into your 20-year re-balancing plan and the market has gone through a remarkably good period, you could consider selling your entire investment in the stock market. You only want to do this if selling now would still leave you with enough to meet your goals. So if you are 10 years away from retirement, but the recent run-up in stocks has left you with more than enough for your retirement, then you could reasonable decide to take those gains and run.
If you’ve reached your goals and you decide to sell, you just have to be OK with the fact that you may miss further stock market gains. But on the flip side, you also will miss any crashes. Just remember that you’re investing in the stock market to reach reasonable goals that you’ve set for yourself. You shouldn’t be in it to beat every other investor out there.
Invest Like a Machine
When you are investing, your emotions are your biggest enemy. Your emotions are what will be screaming at you to sell when the market is already down, and screaming at you to buy when the market is up. Your emotions are trying desperately to derail your plan. You can try to force your logic to overpower your emotions by sheer will power, but this is exhausting. And eventually you will likely cave in to your emotions. Instead, rely on automation.
Automate as much of the process as possible to protect your investments from your own emotions. Use the tools that your mutual fund company or your employer’s 401k offer you to set up automatic investing. If they offer free automatic re-balancing, even better.
Spread Your Risk
The last thing you absolutely need to do to be at peace with the stock market is spread you risk around. Although the market as a whole will continue to gain over the long term, not every individual stocks is guaranteed to do so well. Companies do fail, and when a company goes bankrupt, its stock becomes worthless, or very close to it. Even if a company doesn’t completely go bankrupt, it is fairly common for companies to languish in a slump for years without making significant profits. And no matter what you tell yourself, you can not guarantee that you will be able to avoid bad investments.
Spreading your risk around insulates your investment from being destroyed or held back by a handful of bad stocks. One way to spread your risk is by buying a wide assortment of individual stocks and bonds. However, doing this increases costs and time invested. A far easier, cheaper, and effective way is to invest in a broad passive mutual fund, such as the Vanguard Total Stock Market Fund. A fund like this comes with dirt cheap expenses, and gives you a wide, inclusive slice of the market. You also get a modest dividend, which will continue to be paid out, rain or shine. You can choose to either re-invest it, or enjoy the passive income.
Ignore Your Investments
If your investments are automatic and you’re in for the long haul, there’s no reason to look at your investment balances. Better yet, don’t watch the stock market at all. Have faith that over time, the economy will continue to do its thing. Barring a total collapse of capitalism and a return to the dark ages, your investments will continue an upward climb. So when everyone starts screaming about the market collapsing, shrug your shoulders and ask ‘so what?’
While I do strive to only write accurate information and dispense valuable advice, I am not a licensed financial adviser. All information is based solely on my personal experience and personal research and should be treated as such. Find out more.