Investing in a Volatile Market
When investing in the stock market remember that markets will fluctuate and there will be years with negative returns. Keep a long term perspective and don’t make decisions based on short term volatility. Events impacting the market are generally less catastrophic than they first appear. The media and industry pundits tend to exaggerate negative information to create news and get attention. It’s natural to assume that things are different this time or there is currently more geopolitical and economic uncertainty than normal. But, economic and political events always feel more traumatic while we are living through them. Volatility and unrest is not unusual when we look back at historical events impacting the market over the years. Over time, the market has weathered many dramatic events and has still managed to provide an average annual return of about 10%.
To successfully navigate the stock market, understand your time horizon and your liquidity requirements to establish a long term plan. Avoid emotional reactions to short term market fluctuations and don’t time the market. Studies have found that the average investor earns significantly less than the market average due to market timing and emotional reactions to market fluctuations.The market is counterintuitive and we are easily caught up in a cycle of buying high and selling low. When the market increases, we feel good and don’t want to miss an opportunity to make money. As a result, we buy stock when the market is at its peak. Alternatively, when the market drops we worry about losing money, and eventually sell when the market is near the bottom. It’s hard to make money in a cycle of buying high and selling low, so establish a solid plan and stick to it.
To ride out market fluctuations, establish a solid financial foundation and maintain an asset allocation that meets your investment timeframe. Create a solid financial foundation by living within your means, minimizing the use of debt, and maintaining an emergency fund. A strong foundation helps you avoid pulling money out of the market at inopportune times when an emergency arises.
Maintain a portfolio that supports your investment timeframe. Generally money needed in the next five years should be held in safer, fixed income investments such as cash, CDs and short term bonds. But don’t give up on stocks. Keep a significant portion of your long term money in the stock market to provide growth needed to meet your financial goals and stay ahead of inflation.Additionally, diversify across a wide variety of investments to help buffer against market volatility. Reduce your risk by diversifying across different companies, municipalities, industries, and geographical areas. When one type of investment is doing poorly, another may perform well. Investing in different types of mutual funds can provide an excellent way to diversify. Mutual funds pool your money with that from others to invest in a large number of companies or government entities based on predefined investment objectives.