As we all know, the stock market is very volatile. The stock prices can go up and down dramatically affecting not only your net worth but your state of mind as well. It is generally recommended to be invested in stocks for at least 5 years, as the long term trend of the stock market should be upwards. However, how do you tackle the volatility of the stock market while waiting?
1. Do Not Invest Money You Cannot Afford To Lose
When you invest, you always have to invest with your financial goals in mind. For example, If you are close to 30 and you are planning to get married and saving to buy a house. don’t invest the money which you are saving towards buying a house into equities! If you have no immediate needs such as buying a house or having children, you can safely put more money to work. Investing in equities is inherently risky in the short run and there is no guarantee that you will be able to liquidate without any losses when you need to. The worst that can happen is that when the prices of houses fall to an affordable level, you are stuck in equities and cannot get out without sustaining huge losses. When you are investing with money you cannot afford to lose, you will most likely suffer from stress, heartaches and sleepless nights when the market tanks.
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2. Avoid Unnecessary Leverage and Margin
While leverage can be a nice tool to use to magnify gains in a booming market, it can be very damaging to your portfolio if done in excess. If you take on a 10% margin on a stock you own, a 10% drop in price would wipe out your stock holding entirely. No matter how fundamentally strong a Company is, if the market sentiment is down, the stock price goes down. A person using borrowed money to trade will not have the holding power to withstand the price volatility.Especially for a volatile asset class like stocks, leverage above 30% is generally not recommended if you intend to invest for the long term.
3. Diversify Your Stock Portfolio
Your stock portfolio should ideally consist of stocks from different industry sectors and different geographical regions as well. The problem with a concentrated stock portfolio is that should a few stocks experience volatility in their stock prices your portfolio would be affected greatly. Stocks from different sectors and different geographical regions tend to have different market cycles, so while some is up, some may be down helping to balance the portfolio. By diversifying, you reduce the risk of making the wrong investments and also experience less volatility in the portfolio.
4. Do Your Own Research and Ignore Market Rumors
A main reason why many panic when they see the stock market drop is due to a lack of research. They do not understand the companies which they are buying and get easily affected by market rumors. By doing your own research, you will have a better idea of the stock market value and will be able to stay convicted even in market uncertainty.
5. Establish a Cash Reserve for Emergency Usage
A smart thing to do will be always to set aside some cash for emergency purposes. Emergencies can range from hospitalization of a loved one, layoff from work or so on. An employee who is laid off may require anywhere from one month to six months to look for a new job. Therefore, the recommended time frame for a cash reserve is a minimum of six months of basic expenses. That way, one should feel relatively secure and also be more likely to stay clear headed when the economy looks gloomy.
6. Never Invest Fully! Always Set Aside an Investible Portion in Cash
Most of the richest investors like Warren Buffet make most money when the market crashes. However, if you are already fully invested with the money you have set aside for investing, you may miss the buying opportunity a down turn provides. So you should always set aside a portion in cash, be patient and wait for compelling valuations when the market crashes.
About the Author
Calvin Yeo is the Managing Director of Doctor Wealth Pte Ltd (www.drwealth.com), which is an online financial planning platform. He is also a Chartered Financial Analyst (CFA) as well as Certified Financial Planner (CFP).
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