“Are you investing the right way for your situation?”
- Think about how long you plan to stay invested, your financial needs, and how much risk—or changes in portfolio value—you could tolerate.
- Consider how much of your investment mix should be in different asset classes (such as stocks, bonds, and short-term investments) that offer the return potential needed to help you meet your goals with a level of risk you can live with.
You should get invested. Get in the markets. Stay in the market.
Investing can be one of the best ways to help achieve your financial goals. But first you have to figure out what to invest in.
Stocks have historically provided higher returns than less volatile asset classes like cash alternatives and bonds, and those higher potential returns may be necessary in order for you to meet your goals. But keep in mind that there may be a lot of volatility (market ups and downs) and there is a generally higher risk of loss in stocks than in investments like bonds. Over the short term, the stock market is unpredictable, but over the long term, it has historically trended up.
Bonds can provide a steady stream of income by paying interest over a set period of time (as long as the issuer can keep making payments). There’s a spectrum of risk and return between lower-risk bonds and those that are more risky.
Because bonds have different risks and returns than stocks, owning a mix of stocks and bonds helps diversify your investment portfolio, and mitigate its overall volatility. Adding different types of investments to your mix with varying levels of risk and potential return can potentially help your investment mix weather different types of market environments and help smooth out the ups and downs of your overall portfolio.
It’s important to understand that diversification and asset allocation do not ensure a profit or guarantee against loss—but they may help you reach your investment goals while taking on the least amount of risk required to do so.
Diversification can reduce the overall risk in your portfolio, and could increase your expected return for that level of risk. For instance, if you invested all your money in just one company’s stock, that would be very risky because the company could hit hard times or the entire industry could go through a rocky period.
Asset allocation refers to the way you spread your investing dollars across asset classes—such as stocks (US and foreign), bonds, and short-term investments (such as money market funds)—based on your time frame, risk tolerance, and financial situation.
“Stock market dips are part of the ride in stocks”
Before you get started investing, you’ll want to answer a few key questions:
- If the stock market dips 30% or more and takes your account value down with it, how unsettled will you be? Your investment mix should be one you can live with through down markets and still hit your goals.
- What is your financial situation like? If there’s a high chance that you may need to sell investments to make sure you can eat or keep your house, your investment choices should reflect that.
- How long will you be invested? Your investment mix will be very different if the answer is 2 years or 20 years. All 3 factors are important but the amount of time you can stay invested is possibly the most critical when choosing an investment mix.
Keep your time horizon in mind when you’re investing in stocks for the long term. Having most of your money in the stock market is essential when investing for retirement. Plus you should consider some exposure to stocks, even during retirement.
The equity markets are unpredictable and market volatility may be scary. But, you have to be in the market to have the magic of compounding. While past performance is not guarantee of future results, there has never been a 20-year period when stock returns were negative.
You don’t have to invest all at one time for the fear that tomorrow is the day the market goes down. Instead, get in the habit of investing regularly by moving a portion of your cash savings into a diversified portfolio each month. Use a tactic called dollar-cost averaging to put that money to work for you. This approach of “dollar cost averaging” ensures you buy more shares of an investment when the price is low and fewer shares when the price is high. If you have a significant amount of money to invest, dollar cost averaging will reduce the impact of market volatility on large purchases.
But don’t sit on the sideline in cash for too long because no one can predict when the market will take off and melt up.
References:
- https://www.fidelity.com/spire/annual-financial-review
- https://www.fidelity.com/viewpoints/personal-finance/how-to-start-investing
- https://www.schwab.com/resource-center/insights/content/5-most-common-money-traps-to-avoid?cid=25175195%7C6069808%7C144436329%7C292984204
Investing involves risk, including risk of loss.