If you're a new investor, you may have understandably been spooked by the ups and downs in the stock market earlier this year. However, think twice before you pull out your money. Assuming that you have three to four decades of investing ahead of you, understanding these three things about investing will give you a head-start: the benefits of a Buy-And-Hold strategy, ignoring short-term volatility and re-balancing your portfolio.
The Benefits Of A Buy-And-Hold Strategy
A buy-and-hold strategy means that you are invested in the market for the long haul. You establish a sensible plan based on your age, income, lifestyle and projected retirement goals, perhaps with the help from your investment advisor or financial planner, and you stick to it, regardless of the ups and downs of the market.
You understand that the financial markets are noisy and that the financial media have a tendency to exaggerate turmoil. In other words, you learn to stop worrying about the things you can’t control – politics, oil prices, steel tariffs – and to focus instead on what you can control: saving and investing enough to achieve your long-term financial objectives.
Ignore Short-Term Market Volatility
Statistically, investors who try to time the market (i.e. buy and sell their holdings whenever they feel ‘it’s the right time’) make about 4% less per year than buy-and-hold investors. In fact, systematic investing through a 401K or dollar cost averaging (i.e. making a set investment every month instead of trying to time the market) into an investment account gets you better results. Additionally, even though the stock market is more volatile than the bond market, historically, the stock market’s gains have outperformed its losses over the long term.
Rebalancing Your Portfolio
Instead of trying to time the market it is more helpful to investors to rebalance their portfolio every five to 10 years. Most investment portfolios are made up of a combination of stocks (or equities) and bonds (fixed income). From the age of 20-40 years old a 100% allocation to equities is fine. By the time you retire, however, it would be prudent to have a combination of 70% in equities and 30% in fixed income (or even 65/35 or 60/40 depending on your specific situation).
The reason is that by that time, you need to have access to your funds without the risk of too much downward volatility, which would reduce your income in retirement. The only time that an investor younger than 40 should have investments in fixed income is for short term cash needs, so when you’re saving for the down payment on a home, for example.
How To Get Into The Stock Market
So how should you go about building a portfolio? Our firm invests clients in separate stock and bond portfolios, mutual fund portfolios and ETF portfolios. We don’t recommend buying individual stocks to investors investing less than $500K because of the transaction costs. For example, we typically invest in 40-48 stocks per portfolio. At $4.95 per trade, buying 48 stocks would cost you $238. We believe that mutual funds with no load nor a transaction fee are appropriate for smaller investments. ETFs without transaction fees would also be appropriate.
It seems counterintuitive but bear markets actually give investors the opportunity to buy good companies at a deep discount, or buy the whole market at discount.