Lately, it seems like the stock market is going CRAZY! It’s going up 200 points, then down 200 points, in the blink of an eye. In this environment there is one question at the forefront of a lot of people’s minds: should I just stay away from the stock market altogether? Is it too risky right now?
To answer this question, let’s look at some factors to consider when asking yourself whether or not to invest in the stock market. First, though, let’s talk about risk.
In order to achieve FIRE, you need to have your money work for you so that you can afford to stop working. In order to do this, you need to invest your money one way or another by investing either in the stock market, real estate, or a business. The thing is, by making that investment, you’re also taking on a level of risk. Investment ALWAYS involves some risk- that’s to be expected. The real question is: how much risk can you afford to make? Despite the risk, remember that investing isn’t gambling because the investments that you make should be thoroughly researched and you should be confident that you will earn a solid return on investment.
The main point here is this: when investing, you always need to think about both your LEVEL OF RISK and your POTENTIAL REWARD, in tandem. Higher risk can lead to higher rewards but also to higher levels of loss.
Alright, now that that is covered, let’s move on to the factors you need to consider when evaluating whether stock market investment is too risky for you.
Is the Stock Market Too Risky For Me? Things to Consider
1. Do You Have An Emergency Fund?
If you don’t, then, yes, it is too risky to invest in the stock market. The reason for this is because should face some sort of emergency, the last thing you want to do is to have to sell off your stocks. If the only money you can access would be in the stock market, then you are not in a stable enough financial position to be investing. Remember- only invest money that you won’t need to touch for decades, even in case of emergency.
2. Do You Have High-Interest Rate Debt?
If you have high-interest rate debt then, yes, it is too risky for you to be investing in the stock market. This is because debt works against your wealth-building ability. Your number one priority should not be to invest in the stock market but to be paying off that debt as fast as possible. While stock market returns are not guaranteed, you can guarantee that if you put money towards paying off your debt, eventually that debt will be wiped out. So in that way, paying off your debt is a much more secure way to improve your financial position.
3. What Is Your Time Horizon?
If you will need to begin pulling from your portfolio in a very short period of time, then, yes, it is too risky for you to be investing in the stock market. The stock market can be very volatile over a short period of time, which is why it’s a much safer bet when you plan to leave the money in for a long time. The risk level is significantly increased with short-term volatility.
4. What Are Your Specific Goals?
If you don’t have established goals BEFORE you enter into the stock market, then, yes, it is too risky for you to be investing in the stock market. If you have no specific goals, then you’re investing in the market blindly. When you invest with a goal in mind, on the other hand, you’re going in with a plan, and part of this plan involves doing research and making investments that SUPPORT THAT PLAN.
5. Do You Need To Borrow Money to Invest?
If you need to borrow money to invest, then, yes, it is too risky for you to be investing in the stock market. In times like this, when the market has some really low dips, some people may feel compelled to get in as soon as possible so they don’t miss the dip. This can become really problematic if they don’t have the cash on hand to invest as much as they’d like and instead choose to borrow money to make these investments. This is a BAD idea! Doing this is probably one of the riskiest ways to invest because some of the loans that you borrow from may come due before you’re able to get the return on your investment. DO NOT DO THIS.
6. What Is Your Money Mindset?
If you get anxious when you see the market crash, then, yes, it is too risky for you to be investing in the stock market. You shouldn’t be investing if doing so will keep you up at night. As serious investors, Amon and I very rarely check our accounts and definitely aren’t thinking about the market every night. Most successful stock market investors are like this as well. On the other hand, the type of people who check their accounts daily is probably also the type to get easily swayed from the PLAN.
The more preoccupied people are with how their account is doing, the more likely they are to tinker with their plan and try to time the market, sometimes getting so anxious that selling their stocks altogether, even at a loss, may seem like the best course of action. Take it from us: this is rarely, if ever, the case.
Now, let’s discuss some of the things you can do to mitigate the risk for you when investing in the stock market.
How to Limit Your Risk in the Stock Market
1. Do Your Homework
By researching what you want to invest in and really understanding the components of your investment portfolio, you can reduce the inherent risk of investing. When you do your research, you’re not just following the herd or doing what others told you to do- you’re making your OWN decisions, meaning you can invest with confidence and set realistic expectations for the returns that you will be getting on those investments.
2. Develop a Plan
Make sure you have a plan developed while you’re thinking clearly. Have this plan ready to go BEFORE you get into the chaos of investing during a stock market crash, because at that point you might not necessarily be thinking clearly. In times of uncertainty, a plan can help you stay on track and stay consistent with your investing strategy.
By investing in a basket of stocks as opposed to one individual stock, you’re able to spread your risk across multiple areas, industries, and companies. Diversification is a time-tested method of reducing your risk when investing in the stock market.
4. Invest in Bonds
Placing a portion of your portfolio in conservative assets like bonds, CDs, or cash, is another way to reduce your risk. Investing in bonds, for instance, can add a little more security to your investments as they are less aggressive and therefore much less risky than stocks. That said, while bonds can lessen your risk, they will also lessen your reward and reduce potential returns.
5. Automate Investments Using Dollar-Cost-Averaging
This investment strategy involves investing the same amount of money, at the same time of the month, on a regular basis. This minimizes the anxiety and risk of putting money into the market in a lump sum at one specific time. From a pure risk perspective, regardless of whether dollar-cost-averaging or lump sum investing is more effective in terms of returns, taking an automated, dollar-cost-averaging perspective is less risky.
Your money mindset is probably THE most important factor when it comes to investing in the stock market. It takes a lot of character and strength to invest in the stock market at a time like this. But at the same time, it is also the best time to invest right now because it is during a bear market that people tend to make the most money in the stock market. That said, if your money mindset is not in place, the volatility of th market might simply be too much for you and it might be too risky for you to go on this adventure of financial independence.
Take this, not as discouragement, but as ENCOURAGEMENT to get your money mindset right, before jumping into the stock market! Good luck!