After the financial crisis of 2008, the media was full of investing horror stories: retirement accounts reduced by half, plunging stock values, and declarations that investing was too risk dominated the headlines.
However, what many failed to realize was that those who experienced the steepest losses had locked them in by panic-selling when the market was low. Frightened by the financial crisis and the plunging stock market, they pulled their money out, and refused to get back in until the recovery was well under way. If these investors had left their money in their accounts instead of pulling out, they would be experiencing significant gains right now.
“A large part of success will be based on the investor staying focused on the long-term potential and maximizing the compounding effects in their portfolio,” says Matt Pett, the President of CoreCap Investments.
That’s easier said than done when everyone around you has panicked into selling their investments. What you need is a long-term investing plan that you can feel good about — even during the downturns. If you want to feel better about your long-term prospects, here are some ideas from Pett:
Get your finances in order
“First and most important to creating a long-term investment plan is making sure you are not living beyond your means,” Pett says. “If you are, start with a financial plan that will create a rainy day reserve, pay off high interest rate debts, and max out any retirement plans if possible.”
The idea is to make sure that your financial situation is stable enough that you don’t need to worry about the vagaries of the market during the short-term. If you look at historical data, you will see that, even though things get choppy in the short-term, the long-term trend line, over a period of decades, smooths out and heads higher. If you have your finances in order now, you can feel comfortable about letting your investments ride through tough times.
Know what you want to accomplish
Too often, investors just set money aside, without taking the time to understand what’s important to them, or what they want their money to accomplish. Pett suggests that you think about what you want your money to accomplish over time. Do you hope your investments will fund your retirement? Would you like them to help pay for your child’s college?
Once you know what you want your money to accomplish, you can begin setting up appropriate accounts and allocating your assets so that you have a better chance of reaching your long-term goals.
Determine your risk tolerance
“Are you willing to take on increased risk for the possibility to achieve higher returns?” says Pett.
Understanding where you stand with regard to your risk profile is important. If you have a low risk tolerance, you don’t want to pick individual stocks. Instead, it makes more sense to invest in index funds. While you may not beat the market, at least you are likely to keep pace with it. “At a minimum, you should invest in a plan that will keep pace with inflation over time,” Pett suggests.
Your risk tolerance is composed of two main parts:
- Financial, which includes the amount of money you can actually risk.
- Emotional, which accounts for your ability to handle the ups and downs of the market on an emotional level.
Understanding how you operate is essential to creating a plan that fits with your needs, and allows you to feel a little more comfortable about weathering market storms. Look at your financial situation and your emotional situation, and create a plan that allows you to manage both issues comfortably.
Know your time horizon
Finally, make sure you know when you will need your money. “The longer your time frame, the more risk you can take,” says Pett. If you won’t need the money until you retire in 35 years, you have more time to recover. Acknowledge that when the stock market is going through a down cycle to help keep you from selling low and locking in short-term losses.
You should also pay attention to time horizon for other goals. The plan you use when you invest for your child’s college education in 10 years should be a little different from the plan you use for your retirement investing.
Block out the noise
Now that you have an investing plan that you are comfortable with, you need to make sure that you stick with it. Getting help from a financial professional can be one way to ensure that you put together a good road map for the future, and it can also give you peace of mind. Work with someone who doesn’t earn money for trying to sell you specific products, or from someone who is a Registered Investment Advisor and required to help you do what’s best for you.
Once you have your plan, stick with it. The most successful long-term investing plans are those that include regular contributions each month so that you consistently build your portfolio, and those that focus on the big picture. If you can block out noisy panic and keep with your long-term plan, rather than selling because of fear, you’ll be in a much better place for the long haul.