With the recent crash of the Stock Market and continued weakness in the housing market, people are scrambling to find “safe” places to invest. Many people are taking their money out of the market in fear that the system will crash. There are many valid reasons for doing this. However, if the primary reason is that you are afraid of the current volatility in the market, you could make an extremely costly mistake.
Selling now and buying back into the market when the economy recovers is in essence, attempting to time the market, which is extraordinarily difficult to do. Even worse, simply hoping that the economy recovers and that you will avoid losses by selling is speculation and does not involve any true analysis. The following are some guidelines that I like to follow.
1. UNDERSTAND YOUR FINANCIAL SITUATION
Have a strong understanding of how steady your household income is (future raises, possible fluctuations, and changes in employment). Have a grasp on your monthly expenses including not only big ticket items like mortgages and taxes, but also entertainment, gifts, and traveling expenses. You should be able to estimate how much money you have left over to invest every year, after creating an emergency fund.
2. ESTABLISH CONCRETE GOALS
Project how much wealth you would need to accumulate to retire comfortably, taking into account inflation and rises in living costs. Other goals could include college tuition for the kids or buying a new home or vacation home. Goals should be realistic and have an estimated price and time horizon.
3. REALITY CHECK
Calculate what rate of return you would need to accomplish your goals. You may find that buying the perfect house or retiring with houses in Florida and New York is not attainable unless you change your current spending habits. Evaluate your current financial situation and see if there are places where you can cut spending (restaurants, pricey gifts, traveling).
4. DEVELOP AN INVESTMENT STRATEGY
Your risk preference, financial goals, and time horizon should dictate what type of investment strategy you will use. If you live a relatively frugal lifestyle and you do not have a taste for the fancier things in life, you may choose to minimize your exposure to risk and invest in Bonds and Treasuries. If you are relatively young, with a steady flow of income, and have expenses under control, you could take on more risk gain added return in the Stock Market, Futures, and maybe even fund certain startups in addition to investing in Bonds, Treasuries, and Real Estate. Make sure you modify your strategy and minimize risk as you approach certain target dates when you will need to withdraw funds.
Pay attention to asset allocation and work towards minimizing risk to your overall portfolio, not just through each individual investment. Make sure you minimize correlation between investments and make sure they are affected by different economic factors. Diversify across industries and Time. In Real Estate, diversify by buying properties in different market areas and across different property types (condos, multi-family, single family, apartment complex etc.).
There are all types of investment strategies that will appeal to different types of people with different financial goals and risk preferences. What is critical is that you manage your finances in a systematic way, seek help from a competent financial advisor, and avoid speculation, especially in the current economic environment.
Photo Credits: Pete Travels, Purpleslog