A shaky stock market makes people nervous. Naturally, they're scared of losing money. Alex, a reader in the U.K., wrote to say that he's finally ready to begin investing, but he's not sure that now is the time to do so. Should he wait?
I recently switched jobs to one that pays me better (and makes contributions to a pension!). My current savings are healthy enough to be considered an emergency fund; if I lost my job tomorrow and tightened my belt it would carry me through a couple of months of unemployment. I am 23.
I have never been so financially rosy, and I am certainly rosy enough to start investing. You've convinced me that index-linked funds (I'm talking about the things that track the stock market) are the way to go — a decent balance between risk and reward. But as we all know, things have been a bit rocky on the stock market lately.
Should I be investing now in a kind of buy-it-cheap kind of way, and accept that ‘plummeting prices' just mean a loss of 1-2% that will be made up for in the long haul? Or should I wait a couple of months and keep that money in my current account, and make an investment in the new year when things are a little less volatile?
Alex is hoping to get some U.K.-specific advice. Because I'm unfamiliar with foreign markets, I'm going to use the U.S. stock market in my examples. I welcome comments that apply to all markets.
The short answer is: nobody knows what the stock market is going to do, and all attempts to guess simply amount to market timing, which is what the experts warn against. There's a significant chance that the market will drop more than just 4-5% during the next year — it could drop 10-20%! But history has show that with time, the market will increase.
Looking at QQQQ, an exchange-traded fund that tracks the NASDAQ index, you can see that the share price tumbled 15% this month. But the price is still nearly double what it was five years ago. The market is volatile. Prices swing up and down. Looking at short-term history is baffling. But looking at the long term shows a general pattern of growth. Pay attention to the long-term — the short-term will only cloud your judgment.
For myself, I've decided to trust the advice I've read over the past few years, advice that says if I make regular investments in index funds, the value of my money will increase with time. It may not always increase — in fact, it may see some significant declines — but it will generally increase.
Indeed, when an index fund declines in value, it doesn't bother me. I look at it as an opportunity for me to buy in at lower cost. But if an individual stock declines by a similar amount, I get very nervous. An individual stock is not diversified — if it drops, there are no other stocks there to buoy its value.
If you're worried that the U.S. stock market faces a rocky future, consider tucking some of your money into index funds that track foreign markets. For example, I have money in EFA, which is an exchange-traded fund that tracks European and Asian stock exchanges. (EFA is not the only option — there are other index funds of this sort. It's simply the fund that I decided worked well for me.) But be aware that foreign markets have their share of declines, too. This month, both QQQQ and EFA are down sharply.
Ultimately, only Alex can answer this question for himself. Only he can decide whether now is a good time for him to buy index funds. But my own answer is that every time is a good time for me to buy index funds.
Yesterday's issue of USA Today featured a story called “Where's the Best Place to Plant Your Money?” Here are some related articles from the Get Rich Slowly archives:
- What if the stock market makes you nervous? (This article includes links to risk-tolerance quizzes.)
- What the stock market decline means for you
- Saving and investing: What is a stock market index? (a video presentation)
- Intro to mutual funds: Index funds (a guest post from Vintek)
What about you? When the market's down, do you get cold feet? Or do you view it as an opportunity to buy? What's your advice for a new investor like Alex?
Updates: In the comments, Brad makes a very important point: “The crucial issue in making this decision is your time horizon. If you're investing for retirement and you're young, that's a totally different ball game than if you're investing to make money this year or next.” My comments above apply to long-term investors.
Here are two other video presentations related to this discussion. The second presentation is particularly important — the linked page also includes graphs demonstrating how time mitigates market fluctuations.
- Saving and Investing: An Introduction to Dollar-Cost Averaging
- Saving and Investing: The Impact of Time — READ THIS!
All of the videos I've linked to here are from Michael Fischer, whose Saving and Investing is an excellent introduction to the subject.
Author: J.D. Roth
In 2006, J.D. founded Get Rich Slowly to document his quest to get out of debt. Over time, he learned how to save and how to invest. Today, he's managed to reach early retirement! He wants to help you master your money — and your life. No scams. No gimmicks. Just smart money advice to help you reach your goals.