Haven’t you heard?! The market is falling! The market is falling! Our instinct? To flee. Sure, we’re uncertain, but is it really wise to pull our money out? What about the market’s record-breaking high just a few months ago? Oh, how quickly we forget.
The stock market is no place for emotion. Investing is best done according to a well-considered plan because, to win, we’ve got to ride out its ups and downs. If we can stay invested when the market drops, we can re-gain value on an upturn. But if, instead, we placate our fears and sell, all we do is cement our loss. We convert our temporary loss of value into a permanent loss of money.
Okay… so, what’s the plan? First, get an investment mix with a yo-yo swing that matches our comfort level and “time horizon” — that is, how long we plan to stay invested. If we don’t plan to cash in for another 20 years, what does a big yo-yo swing now really matter? We create opportunity for bigger gains, yet we still have plenty of time to recover from a big drop. By the time we’re ready to retire, though, we’ll need a small yo-yo swing so it won’t matter much if the market is up or down when we cash in.
Mixing investments — aka, “diversifying” — also protects us against any particular investment going bust. If we invest in one company, and it fails, we lose everything. But, if we invest in a bazillion companies, we may barely notice if one fails. And we can diversify like crazy
— in bonds, in stocks, in blue chips and start ups, in developing countries and at home.
Having a regular periodic investment plan guards against our instinct to stop investing when the market is low, which is our best opportunity to buy low. It also guards against our instinct to pour in money when the market is up — also called buying high. By investing regularly, we also get the benefit of dollar-cost-averaging. We end up buying both high and low so, over time, our cost of investing averages out.
Periodic rebalancing insures that we stick to the plan. If stocks are booming, our instinct is to let it ride. If we do, though, our mix becomes more heavily weighted in stocks than what we’d planned. This sets us up for a much bigger drop than one would like, should the market decline. Rebalancing forces us to stick to the original mix by selling some of our booming stock. It forces us to sell high.
Relax. No need to hire a financial team. The financial industry has made it easy with “target-maturity” funds. These funds match our time horizon with the appropriate yo-yo swing, continually rebalance themselves, and gradually become more conservative as we approach retirement. All we do is select our retirement date, set up an automatic investment plan, and the fund does the rest. For starters, check out the line-up of target funds offered by Vanguard and T. Rowe Price.
Certainly, as we become more familiar with stock and bond markets, we may become more able to manage our own investment mix. But, until that day comes… as in both investing and life, a good plan now is better than a perfect plan later.
Berry is not a Certified Financial Planner. She is a cum laude graduate of Texas Tech Law School and manager of her own family’s finances. Before making financial decisions, consider all information carefully and consider consulting a financial professional.
Yo-yo analogy taken from Edelman, The New Rules of Money.