Should we really invest in the stock market now?
The stock market has been bumpy lately and many investors fear their savings are about to take a hit. That’s a scary thought, especially if we’re talking about years of hard work that went into your retirement account. It would be silly to ignore some of the warning signs, but now is not the time to give up on the stock market. The evidence overwhelmingly suggests that a stable approach will result in the best investment returns over the long term.
Fear is a bad reason to avoid the stock market
Withdrawing from the market at this time would be a fear-motivated act, and you should strive to remove emotion from your investment decisions. Fear and greed cloud your judgment. Instead, we can use real data to make decisions.
It makes perfect sense to have concerns about the market at this time. Major indices are just below all-time highs, and strong returns over the past 18 months have made stocks expensive relative to earnings, cash flow and dividends. Interest rates are expected to rise over the next year, and we still haven’t fully recovered from the economic impacts of COVID-19. There is a good argument that a correction is likely to come.
Unfortunately, investors need to take a more sophisticated approach to risk management. The opportunity cost, for example, can be just as destructive as a stock market crash. What if the next crash is still 12 months away and the major indices climb another 15% before the hammer falls? Even if your analysis correctly indicates that there is more downside risk than upside potential at current valuation levels, there is still a plausible scenario where staying invested pays off.
Any good investment strategy assumes that market cycles are inevitable and that equity portfolios are volatile. You should not abandon your strategy just because the probability of volatility is higher than normal.
A crash probably won’t justify the sale
Timing of markets is incredibly difficult. In fact, it’s so difficult that the majority of asset managers fail to consistently outperform the market, even during volatile times when they’re supposed to shine. It’s too simplistic to summarize this as active versus passive investing, but it’s important to establish the likelihood of poor results for investors who are drawn to short-term stock selection. There is just too much that we don’t know and can’t predict, and timing requires a level of precision that no one has really been able to achieve. A small number of days provides a huge proportion of the total growth. Missing them can completely derail your performance in the long run.
Even if we head for a crippling stock market crash, it will only be a temporary setback. Stock market valuations ultimately reflect the cash profits that a company is capable of producing. That leaves a lot of room for interpretation and guesswork if we are talking about a high growth company that could either be gone or 100 times bigger in 20 years. This uncertainty is inherent in investing.
However, the stock market as a whole is less uncertain. The market represents the global ownership of large companies, which generally grow with the global economy. Some businesses and industries will be ahead or behind over time, but the savings tend to grow. Make sure your portfolio is set to absorb an amount of volatility that is compatible with your risk tolerance, and let it collapse. Don’t be surprised by periodic troubles.
Who shouldn’t be buying stocks right now?
Most people should invest in the stock market now, but there are exceptions. There are people who need to cover the basics of their financial plans before they can rake in more money in stocks. Even these cases are temporary – it’s just a matter of lining up their ducks.
The most common group of people who should not invest in the stock market are those with high interest rate debt. The best example is credit card balances, with APRs typically ranging from 15 to 25 percent. It is very unlikely that you will be able to earn a long-term rate of return that is greater than the interest rate on credit card debt. An investor could easily overtake the market every year, but it would always be better if they focused on paying off any high interest debt.
Investors with poorly distributed assets should also consider a temporary halt in the purchase of shares. If you don’t have money set aside in an emergency fund, you might consider selling stocks or building up your short-term savings before making any investments. Many experts recommend saving three to six months of spending cash. Stocks are liquid assets, but they are too volatile to function as a true emergency fund, especially because bear markets tend to accompany periods of high unemployment.
Likewise, anyone over-allocated to equities should take advantage of this time to switch to low-volatility assets, such as bonds. Your investment horizon and your risk tolerance determine what percentage of your portfolio should be invested in equities. If you are overweight equities versus a model portfolio, it’s time to unwind some of those positions. Even then, however, you should almost certainly keep some of your portfolio invested in the stock market.
If you don’t fall into one of these categories, you should stay invested in the stock market. It’s fine to make some modest allocation adjustments to changing market and economic conditions, but it’s highly unlikely to work in your favor if you make drastic changes to your portfolio in an effort to keep the market in sync. Marlet.