Laura answers a listener's question about managing investments when the financial markets are volatile and the economy seems uncertain.
Laura answers a listener's question about managing investments when the financial markets are volatile and the economy seems uncertain.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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Welcome back to Finance Friday, another special edition of Money Girl, where I answer your burning money questions! Today's topic comes from Jennie, who says:
"I'm very worried that we're going to have a recession and I'll lose a lot of money if the value of my investments crash. Should I sell what's in my retirement account and move it to cash, or just stop investing until the future of the economy seems more certain?"
Thanks for your question, Jennie! If the recent market volatility has you second-guessing investing or wondering if you should sell investments to stop further declines, you're not alone.
While no one wants to see their investing account balance go down, history shows that markets correct because stocks recover over the long term. So, it's critical to maintain perspective, especially when investing for long-term goals like retirement.
This post will review six big mistakes investors make in volatile markets, as we've experienced lately. You’ll learn what to avoid so your investments continue working for you.
Thanks for downloading episode 917 of the Money Girl podcast! I'm Laura Adams, an award-winning author, money speaker, on-camera spokesperson, and founder of The Money Stack, a Substack newsletter. You can subscribe for free or become a paid member with access to live educational events!
You can learn more and connect with me at LauraDAdams.com. That's also where you can email your money question, learn more about my books and courses, and sign up for The Money Stack. You can also record a brief question or comment on our voicemail line at 302-364-0308.
6 biggest mistakes investors make in volatile markets
Avoid the following six investing mistakes if market ups and downs make you uneasy or unsure about what to do.
1. Thinking this time is different.
While every market downturn's underlying cause(s) is unique, like a housing bubble, pandemic, or fears about tariff hikes, the US economy and financial markets have repeatedly bounced back and exceeded expectations. While past performance doesn't guarantee future success, the American economy is highly resilient.
Since 1980, the S&P 500–a stock market index tracking the performance of 500 leading US companies listed on exchanges–has dropped 5% or more in most calendar years and 10% or more in about half. Despite that volatility, the S&P 500's average return since 1980 has been about 12%!
Remember that a 10% or 15% market decline isn't unusual. While it might feel unsettling while it happens, it's a normal part of investing.
2. Not sticking to an investing plan.
Your investing plan could be to max out a workplace retirement plan by contributing $900 every other week or a Roth individual retirement account (IRA) by investing $580 a month. Depending on your financial situation and goals, consider automating investing so it happens regularly regardless of the economy or stock market.
In fact, buying investments when prices dip is fantastic because you get more for your money. That's part of a strategy called dollar-cost averaging or DCA, where you invest a fixed amount at regular intervals, no matter if an asset's price is up or down. Over time, the average price you pay for it will smooth out despite market volatility.
3. Trying to time the market.
The opposite of a DCA strategy is making one-off investments when you try to time the market by buying low and selling high to profit. The problem is that you'll likely panic and sell when the market dives, devastating your portfolio because you lock in losses.
If you take money out of the market because you think it will only go lower, you have a 50% chance of being right. If you sell out and aren't in the market during a recovery, it's difficult to catch up. Buying back at higher prices means your returns will be much lower. Missing even a few of the market's best upticks will significantly cut the performance of your portfolio.
Instead of trying to predict the future or focusing on news headlines, remember that the wisest investors never panic or make rash decisions–they stick to a disciplined investing plan.
4. Not rebalancing.
The amount you allocate to various investment classes, such as stocks, bonds, and cash, should match your goals and risk tolerance. The more you want your money to grow and the more comfortable you are with experiencing market fluctuations, the more stock you should own.
For instance, if you have many years to go before spending your retirement funds, you might choose 80% stocks and 20% bonds and cash. However, your asset mix may shift when the stock market dips, so you own a smaller percentage of stocks.
Over time, you can rebalance your portfolio, allowing your investments to benefit from a market recovery. Many investment platforms offer automatic rebalancing, a terrific feature that keeps you on track to achieve your financial goals.
In addition, investing in one or more diversified funds (such as index and mutual funds), which bundle investments, such as stocks, bonds, assets, and additional securities, makes them convenient to purchase. Funds are incredibly diversified because they comprise hundreds or thousands of underlying securities.
Diversification allows you to earn higher average returns while reducing risk. If some securities within a fund lose value, some will hold steady or increase in value, which minimizes potential losses.
READ ALSO: How do wealthy people invest money?
5. Not making the most of losses.
While no one likes to lose money, rules known as tax-loss harvesting allow you to use realized losses on investments in a taxable brokerage account to offset taxable gains and income.
Just be sure to comply with Internal Revenue Service (IRS) regulations on wash sales. In general, the rule prohibits investors from selling at a loss, buying the same (or a "substantially identical") investment back within a 61-day window, and claiming tax benefits.
Note that you can't take advantage of tax-loss harvesting in workplace retirement plans and IRAs because the gains are either tax-deferred (with traditional accounts) or tax-free (with Roth accounts).
RELATED: Is it better to have a traditional IRA or Roth IRA?
6. Moving too much to cash.
A good rule of thumb is to keep enough emergency money in FDIC-insured savings to
cover three to six months' essential living expenses. That could be a lifeline if you lose your job or business income or have significant unexpected expenses. Depending on your financial and family circumstances, you may need more or less to stay safe.
But holding more cash than you truly need in the bank or CDs, instead of investing it, could mean sacrificing much higher returns. As previously mentioned, even if you plan to be out of the market temporarily, you'll likely miss a recovery when prices quickly rebound.
The bottom line is that no one, even the most experienced investors, knows how to get the optimal return by buying and selling investments. Since there isn't a right time to be in the market, if we want to beat inflation and accumulate wealth, we must continually invest for the long term in a diversified portfolio suitable for our timeline, risk tolerance, and goals.
Even the 2008 financial crisis, when stocks fell nearly 50%, was just a temporary setback for investors with a long-term outlook. However, if you have a short time horizon, such as nearing or being in retirement, you can mitigate risk by owning a larger percentage of bonds and cash and fewer stocks.
If you're unsure how to manage investments on your own or during volatility, consider using a robo-advisor or working with a certified financial planner or retirement advisor for customized advice.
Before we go, here's a quick reminder to subscribe to The Money Stack, my Substack newsletter, when you visit LauraDAdams.com. It's filled with money tips, tools, news, challenges, and things I enjoy! You can subscribe for free or become a paid member with access to live educational events.
That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
Money Girl is a Quick and Dirty Tips podcast, and I want to thank our fantastic team! Steve Riekeberg audio-engineers the show. Brannan Goetschius is our director of podcasts, Holly Hutchings is our digital operations specialist, Morgan Christianson is our advertising operations specialist, Davina Tomlin is our marketing and publicity associate, and Nathaniel Hoopes is our marketing contractor.