All three major indexes, the Dow Jones Industrial Average, the S&P 500, and the NASDAQ have set record highs this year. Now we’re seeing a sharp decline and an increase in volatility. So what does this mean for you if you have some money to invest? Maybe you just rolled over your 401(k) to an IRA, sold some property, or received a gift or inheritance. Maybe you’ve decided you want to invest for your children or grandchildren’s future.
But is now the time to get into the stock market?
That depends.
When deciding if it’s time for you to invest in the stock market, the first thing you need to do is decide what you’re investing for — and when you’re investing for. Depending on your goals, the stock market might not be appropriate. Do you need this money in the next one, two, or three years? If the answer is yes, then the stock market is not right for you. Regardless of how it’s been doing lately, the stock market is just too volatile for such short-term investments. But if you have a long-term time horizon — for example, 10 or more years — the stock market makes more sense. This brings us back to the original question: is now the time to invest in the stock market?
When the stock market is so volatile, you might be fearful to jump in. And it’s no wonder. When you listen to the news you hear things like: “we’re overdue for a correction”, “stocks are overvalued”, “we’re in a bubble”, “the next crash is coming”, and my personal favorite, “the market is frothy.” All these scary statements could be true and the stock market could tumble. Look at this past week. But the other possibility is that the stock market will continue to rise.
But here’s the hard truth. Nobody knows what the stock market is going to do. Nobody.
So what do you do? You’ve decided that the stock market is the best place for your money, but you’re concerned about the timing. Is the market going to set record highs again? Or is it going to continue its decline?
You may be thinking it’s better to hold off and wait for a another pullback. By doing this, you’re trying to avoid a sudden drop in the value of your investment. It seems logical, but here’s the problem. How do you know when the stock market is going pull back? How do you know how much it will fall? You may think, “as soon as the market falls 5%, I’m getting in.” But what if it only falls 3% before continuing back up? Following this plan, you could miss the boat. Should you continue to wait for that arbitrary 5% drop?
Another possibility is that the stock market won’t have another pull back, at least not for a very long time. Can you imagine the frustration of seeing the stock market rise while you’re on the sidelines waiting for the right moment to jump in?
If you know that you want to invest this money, and you’ve determined that based on your time horizon and risk tolerance, the stock market makes sense, then you should just go ahead and invest the money. Remember, the stock market is for long-term investing. Even if the worst-case scenario were to happen — like a sudden correction or the beginning of a bear market — there’s time for your investment to recover before you need to use this money.
Let’s go back in time to just before the financial crisis of 2008. Things looked pretty good in 2007. Say you decided to invest a large sum of money in the stock market. You got in on 10/1/2007, a day where S&P 500 closed at 1,557.59. Then it happened. The stock market began its decline. A year and a half later, the S&P 500 was down over 50%. Your investment would have lost half its value. But guess what?
The market recovered.
Ten years after that initial investment, on 10/2/2017, the S&P 500 closed at 2,549.33. If you held on through the crisis, your investment would have gained over 60%. And a year later, the S&P 500 is even higher.
The purpose of this example is to illustrate why the stock market is for long-term investments. And even if you have the worst timing ever, you can still profit if you hold on.
Even with this in mind, there are ways to mitigate the risk of market volatility. For one, you don’t have to put all of your investing money in the stock market. You can allocate a certain percent for stocks and put the remainder in other more secure investments like CD’s, money markets, or bonds. This way you will still get exposure to the potential gains of the stock market while protecting a portion of your money from unwelcome volatility.
Another strategy to manage the risk is dollar-cost averaging. Using this method, you don’t invest all your money in the stock market at once, but invest a set dollar amount over a period of time on predetermined dates. For example, let’s say you have $10,000 to invest. Instead of investing the entire amount all at once, you would start by just investing $1,000. Then a month later, the next $1,000. Then a month later another $1,000, continued until the entire sum is invested. The time period does not need to be monthly. It can be every three months or even yearly. But for this strategy to be effective, you have to be disciplined. Once you decide the dollar amount and the investment schedule, you need to stick with it.
The advantage of dollar-cost averaging is that you’re not fully exposed should a market decline occur. Even better, if it does, and you stick to the investment schedule, you will end up buying your shares at a lower average price.
The key point I want to make is, don’t try to time the market. If you’ve got money to invest now, make your investment decision based on your time horizon and risk tolerance.