Investing in the stock market has always involved some risk. A question stock investors must re-answer on a regular basis is how much risk is too much?
In many ways, risk is a subjective, personal determination. What is too risky for you may be just right for me.
More objectively, younger investors can afford more risk because they have many years to recover from mistakes or bad decisions. Older investors should be more conservative, since a setback may be difficult to recoup before retirement. At least, that’s the conventional thinking.
While that’s still good advice, reconsidering your tolerance for risk is more important than ever. Following the market meltdown which began in 2008, many stock investors have been reconsidering the amount of risk they will willingly accept.
In periods of economic and stock market uncertainty, you can expect volatile markets and volatile markets are risky markets.
Uncertainty equals fear in the stock market. If fear is the predominant market emotion, expect significant price fluctuations as sellers run for the exits when something in the news frightens them while buyers may jump into the market if they perceive bargains to be had.
What does this mean for long-term investors?
The timing of buying and selling becomes even more critical in volatile markets. You can’t know when a dip will become a significant drop or when an uptick might become something bigger.
Since guessing (that’s what it is) on short-term price movements is dangerous, plan your exit and entry in advance with plenty of time to execute a buy or sell.
For example, if you are planning to retire in five years, as soon as you feel comfortable selling, do so. Even if you miss some up markets, you will have most of your money in a safer place (high-quality bonds, Treasury securities, and bank CDs).
Volatile markets make it difficult to plan with any confidence. Over the long term, stocks are probably still a reasonable vehicle. It’s the short term that is risky and difficult.
If you are a stock buyer, volatile stock markets can be good opportunities to pick up great companies at a discount, but you must be willing to hold the stock for an extended period.
It may be tempting to try and capitalize on market volatility by trading of the ups and downs of prices. Unless you are willing to devote a tremendous amount of time to trading, it is a doomed strategy for most people. Even professional traders lose with alarming regularity.