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Sitting out the stock market may be riskier than taking the plunge. Find out how to invest money the right way.
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The stock market can scare the socks off young savers like me. It shoots up and down like a rollercoaster. Watching it go, it’s easy to conclude that investing is super risky. During the pandemic, many stock values dropped by more than half! What’s up with that?
Yeah, you can sit out the stock market. It’s easy — just don’t invest. You’re 100% correct that investing in the stock market could lose you money.
But can you afford not to? Unless you possess a low risk tolerance (many of us do), you probably can’t afford to sit out the stock market entirely. There are too many money-making opportunities to take advantage of — and the alternatives are not so great.
The dollar loses value over time
Inflation eats into the value of your savings. Because of inflation, cash in the bank buys less and less over time. Even just 20 years can make a big difference.
Example: Say you had $10,000 in savings back in January 2000. You stuck that money in a 0% APY checking account and left it there. As of January 2020, you still have the $10,000. But you can buy much less with it. According to the CPI inflation calculator, you’d need over $15,000 saved to match your old buying power. Your money doesn’t go as far as it used to.
You can combat this by investing. Investing in bonds, savings accounts, and certificates of deposit earn you interest. Sometimes, it’s enough to beat inflation — but often, it’s not. Bank deposit accounts are good at keeping money safe, but they’re not great at growing wealth.
The stock market has earned 10% yearly on average
Keeping dollars valuable is important, but what about earning you even more? The stock market is good at this. In fact, the stock market has returned an average of 10% per year over the past 50 years. You can quickly put your money to work by investing in an S&P 500 ETF.
Example: Say you had invested $10,000 into the stock market in 1972. After 50 years, that $10,000 would have been worth $442,000. And that assumes you never added a dime.
Don’t worry about fancy money shenanigans. Only a fraction of fund managers beat investing the easy way. You can keep things simple and profitable by investing in top-performing indexes like the S&P 500. But there’s a catch: investments must match your risk tolerance.
Measure your risk tolerance
When I began investing, I thought I had the mental fortitude of a rock. Then COVID-19 hit, and suddenly, I wasn’t so sure. Why was this investment down while this one was up? Had I chosen wrong? Hold up, my portfolio’s value dropped over 30% in just weeks! I panicked. I sold good stocks and purchased “better” ones…that promptly flopped. Oops. My bad.
My mistake was failing to measure my risk tolerance, which is my ability to tolerate uncertainty. If I had, I might have hedged my bets so the pandemic didn’t freak me out so much. Had I been calmer, I might have made savvier investment decisions.
Two ways to measure risk tolerance:
Take a risk tolerance quizHave a financial advisor measure risk tolerance
Once you know your risk tolerance, you can invest the right amount of money in a portfolio that suits your needs. For many, that means investing in the stock market.
How to save money the right way
To save money correctly, know when you need it. Do you need it tomorrow? Keep it in an easy-access checking account. Need it for a rainy day? Keep it in a high-yield savings account. Need it when you retire? Invest it. You can open a brokerage account in minutes.
The tricky part of investing is staying level-headed.
Here are three ways to improve your risk tolerance:
Diversify investments. Diversification lowers profile volatility.Avoid leverage. Leverage may shrink your tolerance for volatility.Lengthen your investment horizon to five or more years. That way, volatility bothers you less — your stock’s values have time to rise. (As opposed to investing next month’s rent money.)
After losing money to the pandemic, I did all three to improve my risk tolerance. And it’s worked — I’m rarely stressed, and I’ve held all my investments. Things aren’t perfect, but I’m glad not to sit out the stock market. I can’t afford to let inflation eat my money in the bank.
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