The stock market has gone up - should you sell?
The stock market has gone down - should you buy?
These are common questions that make investing in the stock market a nerve-wracking experience for many.
The answer to these two questions is yes or no.
Not surprisingly, that's the kind of answer many investors find unhelpful.
Unfortunately, the correct answer to either question is usually not so straightforward and, most importantly, the correct answer for one person may be the exactly wrong answer for another.
Here's why:
There are several factors you need to consider before finding the answer that's right for you.
1. Consider your tolerance for risk. If you are risk adverse, meaning the thought of losing money or making a wrong decision is very upsetting, you should probably stick with a dollar-cost-averaging approach and forget what the market is doing.
On the other end of the risk scale, if you are comfortable making short-term trading decisions and are willing to take some chances for a potentially higher return, do your homework - no investing on "your gut," "a hunch" or worse, a "hot tip."
2. Your age to retirement is important. Stocks go up and stocks go down, sometimes dramatically. You don't want to have your retirement fund mainly in stocks when the market decides to tank.
The closer you are to retirement, the smaller the percentage of stocks in your portfolio should be. The rule of thumb is to take your age and subtract it from 100. This number should be the percentage of stocks.
3. Are you an investor or a trader? An investor is one who takes a long-term view of the stock market, also known as a buy-and-hold investor. You'll find people who declare this strategy dead and discredited.
The problem with this argument is that the alternative it offers - active trading - is a guaranteed losing strategy for almost everyone who tries it.
If you want to try your hand at active trading, plan to spend a lot of time studying the market and how it works. Also plan to lose a lot of money before you gain enough experience to profit.
Active trading is really a full-time effort for most people, which leaves little room for other activities (like earning a living).
Buy-and-hold doesn't mean buy and go to sleep. The key to making this strategy work is to rebalance your portfolio at least once a year and possibly more depending on the market.
The market will always have some volatility on a daily basis. Your job as a stock investor is to find an investing strategy that fits your risk tolerance, age and investing style - and stick with it.
