You are afraid of what you don’t understand. It’s just as true about investing as it is spiders. A friend mentioned to me the other night that she was afraid of putting money in the stock market. I got excited and almost catapulted into a financial sermon. Instead, I made a comment or two and let the rest of the night take its course.
Yet, I couldn’t stop thinking about my friend’s fear of the stock market, and I needed to know more. A couple of days later, we talked so I could ask more questions. From our conversation I found some common concerns I think we all share.
Side Note: The whole stock market is complicated. For this article, I will be referring to the Dow Jones Industrial Average (DJIA) or the Standard & Poor’s 500 Index (S&P 500). The values of the DJIA and S&P 500 are the most used measurements of the stock market, but they aren’t the only ones.
1. What do I do if the stock market drops again like 2008?
The bad news is that another large drop in the stock market is bound to happen. Good investors know that markets move up, down, and back up again. But it is nearly impossible to predict exactly when the next drop will occur or how bad it will be. In fact, there are investors who have built their entire investing strategy on waiting for the markets to drop, like Nassim Nicholas Taleb.
The good news is that over a long period of time, the stock market rises higher in value than it did before. As long as you believe the global economy will continue to grow and prosper, the value of the stock market will continue to rise.
For a quick history lesson, go to http://finance.yahoo.com and look at the chart of the DJIA or S&P 500. Pick a day with a large drop and look fifteen years into the future. For example, the S&P 500 closed at 248.22 on October 19, 1987, or better known as Black Monday. Almost fifteen years later, the S&P 500 closed at 879.05 on Friday, October 18, 2002. I challenge you to find a day where either index was lower fifteen years later.
Your emotions play a big role in your everyday decisions. As humans, we like to think we have logical control of our lives but it’s not quite true. When it comes to investing, most people make poor choices because of their emotions and what is in the news. You may know that you should buy low and sell high, but recent history shows the opposite happening.
According to a recent Wall Street Journal article, the average investor return on mutual funds is much worse than the total returns. Over the past fifteen years, the decisions of an average investor of when to buy and sell returned an annualized 4.8%. If an average investor had bought some shares and did nothing (buy and hold), the return would be an annualized 6.4%. The difference might seem small, but a $10,000 investment would have grown to $20,203 with a 4.8% return or $25,358 with a 6.4% return.
One of the worst decisions to make when the market drops is to completely sell everything. If you have many years left until retirement or you need the money, letting the market come back is still an option. When you sell, you guarantee your losses and start losing out on any gains your investments could have made.
It’s good to remember that the stock market will go up in value again, but no one knows how long it will take. When you are young, it is easier to weather these storms because time is on your side. If you are older and closer to retirement, it’s time to think about ways to protect your retirement.
You can also turn a market drop to your advantage. One of my favorite quotes about investing is from Warren Buffett when he said, “Be fearful when others are greedy, and be greedy when others are fearful.” The good stocks go on sale when the market drops, and it can be a great time to buy.
2. What if I need money when the stock market goes down?
As I mentioned before, the stock market will go down again at some point in the future. As the world witnessed with the recent crash, businesses run into trouble, jobs are lost, and the economy gets into a jam. Everyone–including me–is afraid of the day when they don’t have enough money to pay the bills. Selling investments or retirement funds should be the penultimate option to help you survive (bankruptcy is the final option).
I have had clients tell me some of their financial choices were made based on what others were doing. One client bought a house before she was ready, and another client leased a car because that’s what her parents did. Both clients became unhappy with their choices, but they learned to do better. The same can be said about saving for retirement.
Companies push employees to save in a 401k, and some companies have made retirement plan enrollments automatic. There are constant commercials for financial advisors and firms that can help you with IRAs and other investments. In general, saving for retirement is a fantastic idea, but there are two key points of personal finance you should understand.
Avoiding extra debt while saving for retirement is important. The Wall Street Journal also reported that “U.S. credit-card balances are on track to hit $1 trillion this year, as banks aggressively push their plastic and consumers grow more comfortable carrying debt.” As your debt balances go up, you add risk to your life. Too many families have their finances on auto-pilot, and their retirement accounts grow along with their debt. Unfortunately, when the market drops again, retirement accounts will go down and most credit card balances will keep going up.
Growing an emergency fund is also a great decision, and it can calm your fears about investing money in the stock market. For most families, I suggest saving between three to six months of expenses. An emergency fund helps you with smaller expenses, and it can be a lifesaver if you lose your job. For example, if the stock market drops and you get let go, your emergency fund helps you survive for six months until you find a new job. You can learn more about emergency funds be reading my article, “How to Stop Money Emergencies from Ruining Your Day.”
A drop in the stock market does not get you into trouble directly, but the effects on the whole economy could affect you eventually. Hopefully, you will use the money in your retirement accounts for retirement. Keeping your debts low and having an emergency fund will help you in times of need and make you feel more comfortable with investing in the stock market.
3. Can I still make money without watching the stock market every day?
It was a glorious day when I realized I can save for retirement without needing to obsess over the stock market. Day trading can be a lucrative career, but it’s not for everyone.
The trouble with instant information is it can overwhelm you. When there is a hurricane in the Atlantic, it’s good to be updated on a regular basis. Yet, financial markets never stop, and financial websites help fuel your desire for more information. The key is to separate the information you need from the rest.
On a regular basis, there is a hot investment everyone talks about. It might be a specific security like gold or a broad market like real estate. Unfortunately, too many people believe they have found the winning ticket and dive all in. Bitcoin is a great example. The mistake is to believe a hot ticket will last a long time. It takes practice to recognize the difference between a hot tip and a long-term strategy.
Day trading is a full-time job, and it takes a lot of time and energy. Professional investors and hedge fund managers do their best to beat the markets and consistently find winners. Some investors may only find one winner out of ten, but if the one is the next Google, the time and energy pay off. My hat is off to those investors, and that career isn’t for me. Even a successful investor like Tim Ferriss can become overwhelmed and take a break.
The first step to a more passive or “set it and forget it” style of investing is to have a goal. Pick a day you want to retire, calculate how much money you need to save, and decide what rate of return you need. There are a lot of free retirement calculators online, and my favorite is at www.calcxml.com. Once you have a target rate of return, it becomes a lot easier to pick an investment strategy for yourself.
With your target rate of return, you should seek an investment strategy that gains what you need while exposing you to as little risk as possible. There are more robo-advisors being created, and these services help you invest without overwhelming you with choices. Two popular services are Betterment and Wealthfront, and they have investment portfolios already designed for you. Choosing the investment mix that is right for you will be easier once you have your goal.
Investing in the stock market can be scary, but the more you know and understand, the easier it becomes. Be sure to have a plan when the market drops because it will happen again. Reduce risk in your life by paying off debt and creating an emergency fund. Finally, you don’t have to be a day trader to make money investing.
These are the most common fears I have encountered when it comes to investing. If you have more, please let me know below in the comments.