This post was originally written in 2017. Back then, the stock market was breaking new highs every few days. Everyone was optimistic and opportunities were boundless. Unfortunately, the good times come to an abrupt end in 2020 as the COVID-19 pandemic sweeps across the world. As a response, governments shut down the economies to minimize the number of death and people getting sick. Most of us are in lockdown and can’t socialize with friends and families. Millions of US residents became unemployed and the stock market crashed. That’s a stark difference from 2017. Life will be very difficult for a lot of people over the next few months while we try to get COVID-19 under control. Investors are in a better financial position to weather this downturn than regular families, but we’re hurting too. March 2020 was probably the worst month of all time for many families’ net worth. In 2017, I wrote this post to help investors figure out if they should invest in the stock market when times were good. Surprisingly, most of this still applies in 2020.
Let’s go over the fundamentals first and then see if investing in the stock market is the right move for you. Then we’ll go over some scenarios. I’ll also add some updates to each section as needed.
Will you need the money?
This is rule #1. If you will need to use the money in the next 5 years, don’t invest it in the stock market. Set that money aside in a safe and easily accessible account instead. If the stock market crashes and you need the money, you’d be forced to sell at the worst time. On the other hand, if you can wait it out, your investment should recover in 5 years. This is a particularly good strategy for index funds. Individual companies might go bankrupt, but the whole market should be fine in the long run.
*2020 update – Many early retirees put aside 1-2 years of living expense. That looked too conservative in 2017, but it’s paying off now. Cash is king when TSHTF. (We set aside 3 months of expenses. That works for us because our income is solid.)
Will it impact your overall strategy?
You have an investment strategy, right? If you don’t know what I’m talking about, then read up on asset allocation first. You need to figure out how much volatility you can handle. A lot of investors sell when the stock market drops and that’s completely wrong. You need to buy more when stocks go on sale. Once you figure out your target asset allocation, you can use that as a guideline and stick with it through thick and thin. If buying more stocks will screw up your target asset allocation, then you probably shouldn’t do it.
*2020 update – It’s hard to figure out how much volatility you can handle when the stock market is going up. You can’t tell because everyone is too optimistic. Now is the time to figure out your asset allocation. Our asset allocation was 70/20/10 (stock/bond/alternatives) over the last few years. This helps limit our losses and I can handle the crash. If you’re losing a lot of sleep because of the stock market volatility, you probably need to be more conservative with your investments.
Where did the money come from?
Where did you get this money to invest? Was it invested in the stock market before? If so, then it’s probably best to put it back in. For example, our dividend income is generated from the stock market. We’re not using it yet so it’s best to reinvest this income. This is particularly important for someone who received a lump sum from their pension. They will be very nervous about investing, but it was already invested before, so the money really should go back to being invested.
Young investors just starting out
This one is a no brainer. If you are a young investor, then invest as much as you can. At this point, your saving rate is much more important than the rate of return. Young investors also have time on their side. Even if the stock market crashes, you will have plenty of time to recover. In fact, young investors should hope for a big crash. That’s the time to buy and it benefits them the most. Just keep investing if you’re in your 20s and 30s.
For example, a young investor has $10,000 invested and lost 30%. That’s $3,000 in total. When you look back in 30 years, this $3,000 loss will seem like peanuts.
I almost forgot. Young investors need to have an emergency fund stash first. This can be 1-3 months of your living expenses in case you need to fix the car or something like that. Don’t put everything in the stock market. Also, pay off those high interest debts before you invest. You can’t beat the credit card interest rate with stock market investing.
*2020 update – I hope young investors read this in 2017 and saved up some emergency funds. 1-3 months of living expense doesn’t sound like much now that the economy cratered, but it should help. The government will also help out so hopefully, that’s enough to help get them through this tough period. If you’re lucky enough to keep your job and have money to invest, now is the time to go all in. Save and invest as much as you can while the stock market is down. This is the chance to give your future net worth a big boost.
Experienced investors getting nervous about the stock market
This is us. We’re in our 40s and we have over a million dollars invested in the stock market. Most of this is in low-cost index funds. A portion of it is in our dividend portfolio to generate usable passive income. In this situation, I need to review my risk tolerance and target asset allocation.
In 2017, our target asset allocation for bonds was 20%. We needed to rebalance and bring the bond allocation back to target. Once we’re back to our target asset allocation, then we will keep investing like this.
- Dividend income – Reinvest in dividend stocks.
- Automated investing – 401k. Hands off here. Automated investing has been working very well for us and we’ll just leave it alone. We’ll continue to max out our 401k every year until we stop working completely.
- Extra savings – This is the extra savings we have after automated investing and paying the bills. The amount is actually very little relative to our net worth. Last year, we saved about $11,000. This year I’ll invest in dividend stocks and real estate crowdfunding.
- Other passive income – Reinvest back into that asset class.
Investing at this point should be relatively easy for people in our position. Most of our net worth is invested and we just need to stick to the plan. The main thing we need to do is to keep investing and rebalance our portfolio once per year. We still have plenty of time before we need to withdraw from our investment.
*2020 update – By the end of 2017, I rebalanced to 70/20/10 (stock/bond/alternatives.) This worked out relatively well for us. Our portfolio didn’t increase as much as the stock market did in 2018 and 2019. However, it is doing better than the market in 2020. That’s as expected and I sleep well.
Recently retired reader
This is an email from one of our readers.
“I am a 60-year old recently-retired, high-school teacher. I am receiving a pension, which has no COLA (cost of living adjustment). I opted to withdraw my contributions with 4% interest & now have a lump sum to invest. It was just deposited into a Vanguard money market account, so that I can easily & quickly buy into my 2025 Target fund (where I have a balance equal to about 10% of my lump sum). I am nervous about moving all of it at once, especially with the unknowns with our president. My plan for this money is to hedge increased future costs, especially medical ones.”
I got more information in a followup email and currently, her pension and her husband’s income pay for all expenses. Since there is no COLA, this investment will help cover inflation and future medical expenses. They plan to take Social Security Benefits in about 10 years.
In this case, I would go ahead and invest the lump sum in the 2025 Target date fund. The money she withdrew was probably invested so I think it is best to put it back to work. The 2025 target-date fund has 65/35 stock/bond mixture. The stock portion will decrease every year so there will be less volatility as they get older. It is a good idea to figure out their target asset allocation and see if the 2025 target-date fund has the right mixture.
From what I understand, they will continue to add to their investment in the next 10 years and won’t need to withdraw. That’s plenty of time for the stock market to recover even if we see a crash in the next year or two. I think she should go ahead and put it in the 2025 Target fund and don’t worry about it. If she needs to use some of the money, then she should keep that portion in cash.
*2020 update – I hope this reader took my advice. If she invested her lump sum in 2017, she would still be ahead even with the 2020 stock market crash. The 2025 target dated fund should be fine too. The mix is now 60/40. It didn’t crash as hard as the stock market and it should recover by 2025.
Do you have any advice for our recently retired reader?
70s and drawing down
Mrs. RB40’s father is in his early 70s and I haven’t seen his investment account in a few years. I really should check and see what he has in his portfolio.
In 2017, he was busy with his rental home in California. The tenants stopped paying rent and he had to evict them. He got a better tenant since then and he’s not stressed out about the rental at this time.
He has a pension, social security benefit, and retirement savings so his personal finance is excellent. His portfolio should be mostly in bonds and other stable investments. The stock portion should be less than 25% of his portfolio. He should not add new money to the stock market at this point. I’ll check his accounts the next time I see him.
*2020 update – Mrs. RB40’s dad is still doing well financially. Unfortunately, I haven’t seen him lately and didn’t go over his investment. My parents had a tough few years and I’ve been focusing on them. Anyway, he’s doing well so we don’t have to worry about him much.
What is your strategy?
*2020 update – Over the last few weeks, I moved some money into the stock market to take advantage of the better price. This is a bit risky, but I’m comfortable with the risk. Our income is still strong so we don’t need to draw from our investment for many years. Now is the time to invest in the stock market if you can stomach the volatility.
Here is my stock market plan for 2020.
- S&P 500 index new high – 70% stocks, 20% bonds/cash, and 10% alternatives
- S&P 500 index dropped 10% – 70/20/10. Stay the course.
- S&P 500 index dropped 15% – 75/15/10. Start buying.
- S&P 500 index dropped 20% – 80/10/10. Buy more.
- S&P 500 index dropped 25% – 85/5/10. Keep buying <<< 4/12/2020
- S&P 500 index dropped 30% – 90/0/10. Getting nervous, but keep buying.
- S&P 500 index dropped 35% – 95/0/5. All in!
- S&P 500 index dropped 40% – 100/0/0 stocks. Really all in… (I don’t count the stuff I can’t liquidate here. For example, we still have our rentals.)
You should come up with a plan for yourself. The easiest thing to do is to come up with a solid asset allocation and just rebalance. So if you can stand 80/20, then just stick with that and rebalance occasionally. The stock market recovered a lot already, but it probably will drop again so this wild ride is not over yet.
What about you? What’s your plan for the stock market? Are you adding new money, pulling money out, sticking to your plan, or something else? Please share your strategy and give us a little background so we can see where you are in life.
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Source: Retire By 40
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