Say what you will about 2017, for the stock market it was a steady year with prosperous gains. In years like 2017 where market values increase with little volatility, it’s easy to get comfortable. This year has snapped us back into reality, however, with market pull-back making investors skittish and perhaps even feeling a little like the sky is falling. With the stable trends of 2017 being an exception to the rule, rather than the standard, we would like to discuss how to successfully ride the stock market wave in anticipation of more volatile years ahead.
First, stop reading the headlines and take a deep breath.
Headlines are meant to catch your eye and create an emotional reaction, that’s how they get readers. When information is over sensationalized, there is likely motive behind it, and you won’t know what that motive is, so refrain from making decisions on overemphasized information. That doesn’t mean you shouldn’t stay informed and consider current situations, but it does mean, you shouldn’t panic.
1. What is your saving objective and timeline? Is it long-term or short-term?
Are you saving for retirement or a down payment on a home? The answer to this question will determine what kind of investment vehicle is appropriate for you and how much risk you should take. Whether you are an independent stock trader, growing your savings or have a retirement savings account, your savings objective and timeline should be clear.
If your savings goal is short-term, for example, saving for a vacation, you are not going to want to risk market volatility and lose a significant portion of your money just before you are due to fly out. In this case, a less volatile savings vehicle is preferable. A high-yield savings account or a money market savings account or even a certificate of deposit will allow you to earn interest on your savings, without the risk that the stock market inherently brings.
If you have savings that invest in the stock market, chances are it’s for a long-term savings goal, such as retirement or future wealth, and the good news is, long-term savings goals can withstand market volatility and in fact count on it to grow. If you are a long-term investor, don’t let the day-to-day changes in the market affect you. Stay the course and evaluate your risk tolerance regularly. The closer you get to needing your money, the less risk you want to take with it. Your investment allocations should reflect the amount of risk you are willing to take based on your objective and timeline.
Which leads to the next question. Just how much potential risk and reward do your current investments have?
2. Is your current investment strategy aggressive, moderate or conservative?
Before you can answer this question, you first need to understand what you’re investing in and in what percentages. If you single-handedly purchase your investments, you likely know full well what kind of investments you hold, but if you have a 401K or IRA through your employer, you may not be aware of what exactly your contributions are purchasing. No matter how or why you are investing, it is essential that you know what you are investing in, and that your contributions are allotted in a way that match your risk tolerance and puts you on track to meet your goal.
So, let’s discuss the three broad investment categories and their risk. Keep in mind that these are general categories, and each has many subcategories.
The three main asset classes:
Stocks (equities): The riskiest of all investments, with the most potential reward. Investing in stock means that you are buying a percentage of ownership in a company. The smaller the company, the higher the risk and the greater the potential return.
Fixed-income (debts): While there are still risks to investing in fixed income, they are considerably less risky than investing in equities. Fixed income investing is essentially lending money to a government, municipal or corporate entity for regular interest payments; the most common example being bonds.
Cash or cash equivalent: This category is any currency or cash you have or investments that can readily be turned into cash. Some examples are savings accounts, money market accounts or funds, certificate of deposits or short-term government bonds (90-day maturity or less).
Your asset allocation or the percentages of investment types you hold in your portfolio (your collection of investments) is what determines if you have an aggressive, moderate or conservative portfolio. Let’s look at some asset allocation examples below.
An aggressive portfolio is appropriate for investors that do not need access to their money for 20+ years and that have a high-risk tolerance and want more significant returns.
Aggressive asset allocation example:
70% stock equities (a mix of large, mid, small cap companies and foreign/emerging stock)
25% fixed income securities
5% cash or equivalent
A moderate portfolio is appropriate for the investor seeking more balance with medium risk tolerance, and that has a timeline of more than five years.
Moderate asset allocation example:
50% Stock Equities(a mix of large, mid, small cap companies and foreign/emerging stock)
40% fixed income securities
10% cash or equivalent
A conservative portfolio is for older investors nearing retirement or an investor that will need access to their money sooner rather than later. Although it is balanced for less risk, it still has some exposure to stock to encourage growth, but far less than moderate or aggressive mixes.
Conservative asset allocation example:
20% stock equities(a mix of large, mid, small cap companies and foreign/emerging stock)
60% fixed income securities
20% cash or equivalent
These are only examples of course and should not be considered investment advice. Your asset allocations should be carefully considered to meet your individual needs.
If you don’t feel qualified to make investment-based decisions, don’t worry! Most financial institutions have funds that have professionally determined investment percentages designed to meet your savings objectives. Your job is merely to determine your savings objective, timeline and risk tolerance. After that, work with your financial institution to put your contributions in the fund that’s right for you.
Which brings us to the third question.
3. Do your savings objective, timeline, risk-tolerance and investment strategy match?
After answering these questions, you will know if your savings goal and timeline match your investment strategy. If it doesn’t, move to a fund that complements the investment strategy that you need or if you are an individual investor, start to invest in places that balance your portfolio to bring you back into alignment.
Temporary stock market dips won’t alarm you if you are confident that you have a mix of investments that reflect the return you want with the risk you are willing to take. When you know that you are on the right path, you can confidently traverse the dips and swells of the stock market. Selling your investments or withdrawing your retirement savings out of panic when the stock market is low only ensures you lose money.
Stock market volatility is normal but thanks in part to the recently stable years, we have become unaccustomed to it. Instead of getting caught up in the hype of a market dip, consider it necessary to bring about substantial growth through accumulating reasonably priced investments and understand that market correction is needed to keep prices from becoming bloated and overvalued. So remember, invest wisely, assess your allocations from time to time to ensure you’re on the right track and keep a level head, that’s how you successfully ride the stock market wave to your savings goals.