You have a lot of choices when it comes to your money. You could buy something fun like a flat-screen TV or a boat, you could remodel your house or you could even take that dream vacation. On the other hand, if you wanted to be a little more practical, you could put your money to work for you and invest it in the stock market. We DINKs love the stock market, mostly because it’s a great way to build your net worth. However, getting the most of out of the market is sometimes easier said than done. Here are some general considerations.
1. Stock Picking Gurus Often Have Poor Long Term Performance
The history of U.S. stock markets is littered with hot stock pickers who ended up failing. For example, famous market pundit Jim Kramer’s investing skill has been unfavorable compared to a monkey. Taking a broader approach Hulbert’s Financial Digest regularly ranks the performance of investment managers and finds that most of them don’t manage to consistently beat market indexes. Take the advice of “gurus” with a grain of salt.
2. Market Timing Can be More Challenging Than it Looks
Market timing is basically the strategy of making buy or sell decisions of financial assets (usually stocks) by attempting to predict future market price movements. It’s controversial, but some people argue appropriately timing markets can significantly boost your returns. Timing is often more challenging than it might seem. A few things get in the way of effectively timing markets, including the need to fully evaluate things like consumer confidence levels, industry specific metrics and corporate profitability, along with economic indicators like interest rates and retail spending. Also you’d need to get good at technical analysis, which is the process of reading charts containing information about trading volume and price). So basically, its hard to identify when markets turn and in order to so effectively you need specialized knowledge.
Your 401k investing experience or just reading the newspaper – has probably convinced you the stock market is a risky place to put your money. However, U.S. equity markets tend to have a strong upward historical trend. Since at least 1926, and adjusting for inflation there has never been a 20 year period when you would have lost money in a diversified portfolio of large company stocks. So even when you account for the impact of inflation and market downturns, if you have a very long time frame you’ll eventually make money.
4. Your Time Horizon Determines Your Risk Perception
With equities, time horizon is the length of time over which an investment is made or held before it is liquidated. Time horizons can range from seconds, in the case of a day traders, all the way up to decades for a buy-and-hold investor. There is no “right” time frame – it depends on the investor’s individual objectives. That said, you should have a longer time horizon (such as 5 to 10 years) if you have lower tolerance for risk. This is because stock market values can fluctuate wildly in the short term and you’d need time to make good on any potential losses.
5. The More You Have In The Market, the Greater The Mental Wear and Tear
As your net worth grows you’ll likely have more money in the stock market. This is because many people tend to invest through their 401k, through mutual funds or via direct ownership of stocks. While the trend isn’t perfect, statistically speaking richer people tend to have more money in equities. However, what this means is the more you have in the market the more you need to be aware of fear and greed. The better you understand your ability to handle fear and greed, the better you’ll be able to stick to sound investment decisions based on knowledge and historical patterns. This becomes even more important the more you have invested.
6. You Need To Be In the Market To Profit
It goes without saying that you’ll never profit from the stock market if you don’t own stocks. But not only is being in the market important, what kind of assets you buy is also important. This is because asset allocation is a big part of investing returns. The profitability of stocks in U.S. equity markets has historically been consistently 3 or 4% higher than alternatives like bonds and cash. Some research also suggests that asset allocation, not picking individual stocks or trying to time the market is the most important aspect of successful investing. In any event you won’t profit if you don’t bother to invest. So having market exposure and understanding asset allocation are required before you can bring in the serious bucks.
So what does all this mean for the individual investor? It means three things:
1. Given the challenges of timing the market, a realistic strategy for the majority of investors would be to invest in stocks immediately. Don’t try to call the market, just go ahead and buy.
2. Long term, it’s almost always better to invest in stocks—even at the worst time each year—than not to invest at all.
3. Dollar cost averaging is a good plan if you’re prone to regret after a large investment has a short-term drop, or if you like the discipline of investing small amounts as you earn them.
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