HELP, I'M CONFUSED ABOUT INVESTING, WHAT SHOULD I DO?

By in Bond, Investing, Stocks | 12 comments

On June 10, one of my MBA students wrote me this email:

Good morning Barb,

This is my first time checking out your site (very interesting). I am so confused on what to believe or even how to evaluate my portfolio. With the international stuff going on, BP oil spill, government legislation, mid-term election quickly approaching. I don’t know what to do. Should I strap in, hold tight and hang on for the wild ride or change my strategy?

Any thoughts????

Your student, BT

As we begin the new year afresh, you may be questioning your investment strategies. Here’s how I tackled BT’s question.

This is a “perfect” investing question. It requires one to ponder; does the present time require a special investing approach? I remember this same question appearing in the media at the end of the 1990’s at the height of the technology boom. Although at the end of the 90’s the question was, “With these incredible stock market returns are we in for a new era with super high returns going forward?” Clearly, that was not the case.

And during the thick of the recession, in 2008, the question of how to handle that situation rose again? An investing forum member even sold every one of her stocks. Many others followed suit and sold at the trough of the market.

Investors frequently wonder, should I get out of stocks because they are too risky, or stop investing in bonds, or avoid cash because the yields are too low? TB, my student voiced concerns that I’ve encountered on investing forums and from countless friends and acquaintance.

HERE IS THE ANSWER

Stocks and bonds are volatile. Historically their returns, especially stocks, are much higher (previous decade excluded) than cash. The reason for the additional return is because we as investors DEMAND to be compensated for the extra risk that stock investing entails.

The answer is very simple, only invest in stocks and bonds to the point where you can tolerate the volatility. The greater the percentage of stocks in your portfolio, the more volatile your investments will be. If you are distraught by volatility, reduce the percentage of stock holdings until you can tolerate the risk. Be aware that when you give up the volatility or risk, you also sacrifice the OPPORTUNITY for higher returns. You really must review the 20 Minute Guide to Investing for a handy “Risk Chart”.

Understand that over the long term, stock investments are very volatile and recently, that volatility has INCREASED. That said, if you don’t need your invested money for at least 5 to 10 years, it’s likely that you’ll be better off financially with at least a bit invested in the stock market.

 I’ve found that after with greater historical information about risk and return, I expected stocks to be volatile, and became relatively calm during times of uncertainty.

In sum, don’t worry too much about the day to day volatility, if you are investing for the long run. As long as you have a sensible investment plan, stick with it. The constant news cycle will give you the chance to buy on the dips and increase your overall return!

How do you handle the ups and downs of your investments?

 If you like what you’re reading, pick up my RSS feed and follow me on twitter so you get the word immediately. 

image credit: Iheartbeatles

    12 Comments

  1. Unfortunately so many are in the same boat as this student! During the boom years, everyone bought stocks without considering the fundamentals. That was probably the time one shouldn’t have been buying stocks! (Be fearful when others are greedy and greedy when others are fearful!).

    When the market tanked, most got out when they should’ve stayed in.

    If this roller coaster gives you too much grief, I would suggest an Asset Allocation strategy using ETFs with periodical rebalancing. In fact if you one is new to investing, this would be a better way to start rather than trying to beat the pros in picking stocks.

    Great post Barb!

    Moneycone

    December 28, 2010

  2. Barb, I couldn’t agree with you more about the importance of not getting wrapped up in the day-to-day volatility of the stock market. If you can’t handle the roller coaster ride, then index funds or something safer is probably the better option.

    Everyday Tips

    December 28, 2010

  3. It took me a long time to learn about risk and volatility of the stock market. Now that I know more about volatility, I stick to my asset allocation and ride out any dips and bumps in the market. Once our contribution slows down, we’ll move to a more stable asset allocation with less stocks, but for now most of our portfolio is in stock.

    retirebyforty

    December 28, 2010

  4. An asset allocation that makes you comfortable is paramount! A diversified portfolio is also important. I have a selection of stocks and mutual funds that are broad enough to weather most volatile markets. My allocation is becoming more conservative as I near retirement.

    krantcents

    December 28, 2010

  5. This really is a tough question to answer! I would have to say that the thing it depends on most is the age of your student. I would say that they should definitely have exposure to stocks, but only as in their asset allocation as they can emotionally tolerate without losing sleep!

  6. @Moneycone-I can’t tell you how many people I know sold their stocks at the bottom out of fear. Your reiteration of the classic maxim about fear and greed it timeless. You sound like your feet are solidly on the ground.
    @Retire-I am intrigued by your plans to “retire by forty” and agree with your plan to stay heavily investing in stocks for now to capture the opportunity for growth. Clearly, you are young enough to ride out the ups and downs of stock investing.
    @Everyday-Even stock index funds won’t protect you from volatility. But, knowledge about historical volatility can help quell the anxiety. You certainly have a level headed approach.
    @Krantcents-You have obviously thought about your finances and have a plan. That is so important.
    @Jacob-Yes, yes. Good advice to all, no more risk than you can tolerate!

    Barb

    December 28, 2010

  7. with index funds, company related risks are wiped out. Add to that a regular contribution and you’ve got yourself dollar cost averaging. Since time is on his side, he will come out just fine in the end without missing any opportunities so long as he doesn’t bother with the day to day noise.

    Identify his level of risk is the best advice you gave your student as it is the key to sleeping well at night!

    BeatingTheIndex

    December 29, 2010

  8. Hi Beating- You touched on all the key points! Very well put, especially the “advanced concept” of wiping out company specific risk by indexing. Thanks for the input!

    Barb

    December 29, 2010

  9. There is a certain evolution to being an investor. Understanding the different investment types, risk and cost should be known and then you get going with the ones you understand a feel confident.

    What I think many forget over time is to review and re-evaluate where they are and what new investment to venture in. If you start with 1,000$ or 100,000$, the strategy will be very different. Having a plan and reviewing it yearly is important and you don’t want to be afraid to make changes (more so if you have an advisor and your are not sure).

    The Passive Income Earner

    January 9, 2011

  10. Another thing that I wonder about recently is to increase my exposure to the international equity asset class. Any thoughts? Currently, my exposure is set to 29% of my equity holdings.

    • Hi Jacob, That’s a tough question to respond to without knowing your time horizon for the money, your risk tolerance, and how the rest of your portfolio is allocated. I can say that my international equity allocation is about 22% of total equity exposure, and that’s on the high side for most US investors. Just be aware that many US companies have large international exposure so your global exposure might be greater than 29%. You might want to check out a cool tool at morningstar dot com called “portfolio x ray.” It gives a really nice break down of your holdings and it’s free!

      Barb

      February 1, 2011

  11. Good point Barb! I didn’t think about the aspect of the global presence of US companies! I’ll have to check out morningstar’s tool! Thanks!

Post a Reply

Your email address will not be published. Required fields are marked *