The Federal Reserve Board announced their decision to fix federal funds rate through at least the next two years. In the same week, Standard & Poor’s — S&P announced that for the first time in history, the United States has lost its perfect AAA credit rating because of the government’s rising debt and increased public spending. Investors are fleeing the markets not knowing how to react to the unprecedented news.
Wild stock prices after press releases are nothing new, but interesting research demonstrates just how high of a correlation there is between the S&P 500 prices and headlines. So, with your retirement invested in a 401k, a business to run, kids to pick up, and groceries to buy, are you supposed to monitor every press release from Ben Bernanke or Standard & Poor’s and take action?
No. In fact, you’re better off if you don’t. These radical changes in stock market valuations are not rational. They are often investors reacting to short‐term news for an investment that should be held for a very long time. Here are three things to consider before making any stock market transactions.
1.) At an absolute minimum, do NOT invest money in the stock market that you may need within the next 5 years. Preferably 10, 15 or 20 years, or longer would be ideal. If there is even the slightest chance you’ll need the money beforehand, do not invest it in the stock market.
Following this rule will allow you a greater chance of riding out any short‐term fluctuations in the stock market. The longer your time frame before you sell your investments, the greater chance your investment will be in positive territory. Look at the photo above of the historical prices of the S&P 500, in the long run, for the most part, it goes up.
2) Diversify your investments. This is the oldest rule in investing, but also the one most commonly violated. Do not put the bulk of your assets in any one type of investment. Spread your money across as many different asset classes as possible; cash, bonds, U.S. stocks, international stocks, real estate, etc.
A very simple starting point is to divide your assets equally in thirds, 1/3 in real estate, 1/3 in interest earning investments, and 1/3 into the stock market. This alone will reduce your risk exposure greatly.
3) This idea may be unfamiliar, but do not try to make money in the stock market. I do not believe that is the reason to invest your money in the market. Contrary to what many in the finance business would have you believe, millionaires and financial independence do not come from money made in the stock market.
The way most people earn their nest egg is through their jobs or businesses. Use those two sources to generate money, and then use the stock market as one of many tools to diversify your wealth.
The stock market is one of the better places store your money to stay ahead of inflation. The value of the dollar decreases a little each year, so ideally your investments will grow at a rate faster than that decline in value. Other less risky investments often do not keep up with inflation, so it’s possible that your CD or money market account, while less risky, still declines in value. Keep this in mind when evaluating why you would put any money at all in the stock market.
The wild headlines are very real and serious issues; however they are usually part of macroeconomics—something you have little control over. Instead, focus on the things you can control and that have the greatest likelihood of helping you reach your goals. Keep your timeline in mind when investing, diversify, and remember the real purpose of investing in the first place.
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*** This is not intended as investment advice and is for educational purposes only***