Stocks Go Up
In the wake of the recent stock market volatility, this post provides the most important investment advice you need to know. First, remember that what goes up must come down. Stock markets go both up and down. This is easy to forget when markets have tripled since the recovery from the Great Recession began in 2008-9. This rise has been even more pronounced since the latest Republican administration took office and promised massive tax cuts primarily to businesses and did in fact almost halve the corporate tax rates. Based upon previous corporate tax cuts, most economists and investors assumed that most of the corporate tax cuts would be passed along to investors in the form of dividends and stock buy-backs which caused the U.S. stock markets to soar.
Stocks Go Down
Now in early 2018 we were reminded about the “markets also go down” part. When data was reported that wages had risen at a higher rate than workers had seen in many years, markets plunged with the DOW tumbling thousands of points. The logic is that tax cuts are good for corporate profits and rising wages are not. In addition to reminding us that markets go both up and down, it should also remind us that stock indexes like the DOW, S&P 500, and NASDAQ reflect investors’ expectation of corporate profits – not the health of the economy.
Stocks Go Up Faster than most other Investments
In addition to this reminder of market volatility, we should also remember that over an extended period of years,
- stocks usually rise and
- few other investments rise as much as stocks.
Most people’s relationship to the stock markets is based upon their 401(k) retirement funds, and of course we were all dismayed to see those fund values plunge after such a steady rise. The media had plenty of people offering us advice on how to handle this, including the oft-repeated advice that “people should know the level of risk they are comfortable with and invest accordingly”. Even though this investing advice is very widespread, it is not only wrong, but dangerous.
Know Your Risk Comfort Level
This investing advice suggests that risk-averse investors should invest in safe investments and risk-tolerant investors should invest in riskier investments. “Safe” investments with low volatility and risk of losing money include bonds, savings accounts, and certificates of deposit. With these, there is little risk of losing your money; however, there is the unseen risks of investments that do not grow fast enough to meet your goals or even losing buying power if inflation grows faster than your safe, low-yield investments. Conversely, risk-tolerant investors may be tempted to invest entirely in fast growing stocks, exotic flavors of mutual funds, stock options, and other enticing, but exotic investments. Even more likely, is that people think they are fine with risk until a downtown scares them and they unload investments at a loss. Or cautious investors sit on their CDs, miss big market rises, and finely start buying stocks again at the top of the rise.
Investment Advice Time Horizon
So, if “know your risk level” is unhelpful and counter-productive, then just what is an investor supposed to do? The answer is simple, easy to implement, and lets you sleep more easily at night. Base your investing upon your “time-horizon”. This means that money you will need:
- within 1-2 years should be invested in safe investments such as savings accounts and certificates of deposit;
- within 2-5 years should be invested in mostly safe, but higher paying investments such as bonds, bond mutual funds, and mutual funds that limit volatility such as “balanced” funds; and
- more than 4-5 years should be primarily invested in a diverse selection of stocks and stock funds.
Dividing your investments in this flexible array based upon investment advice time horizon means that money you will need soon will be available regardless of whether stocks are in their up or down phase. And money you won’t need for many years such as retirement will be primarily in stocks which grow faster than other investments over an extended time period. So even when stocks go down (which they will), you can still sleep at night because you know that stocks’ bear (down) markets rarely last five years and will likely rise again before you need that money. Thus, investing based upon your time-horizon helps ensure that your money will be available when you need it, regardless of the unavoidable fact that stock markets go both up and down. It also means that most of your money can safely be in long-term, high yield stocks that will grow fast enough to meet your long-term needs such as saving for college and retirement. Just remember to reshuffle your three investment “buckets” as the time-horizons of your money goals change.