Investing in the COVID-19 era is intimidating. While the market's generally been rising since mid-March, there are still more than 30 million people out of work, businesses and communities are still partially shut down, and coronavirus infections continue to spread. Under those conditions, market optimism could go sideways in a flash.
As a novice investor, you might feel like your best place is on the sidelines. That healthy level of risk awareness isn't a bad thing, but all-out fear can limit your ability to achieve long-term financial goals. That's because there will always be market downturns. And if your response is to get out or stay out of the market, you undercut your access to growth. A better approach is to learn to mitigate your risk and feel comfortable with your strategy, even in extreme market climates. Here are four ways to do just that.
1. Have enough cash on hand
Your emergency fund is an essential sidekick to your investment portfolio. When you have enough cash on hand to weather bad times, it's easier to ignore the market's inevitable ups and downs. You'll also minimize the chances of having to liquidate right when your investments dip in value.
If you don't have an emergency fund today, start building one. Target a balance that'll cover three to six months of your living expenses. It'll take time to reach that goal, but stick with it. It's not a great idea to halt contributions to your investment account, but if you have to, you could reduce them temporarily to build up those cash reserves.
2. Choose big companies in stable industries
The biggest companies, called large-caps, can power through recessions better than small companies. The big guys have track records, both with their customers and with the financial community. They often have diversified lines of business, solid balance sheets, and ample access to credit. They're not sexy, but they are relatively reliable. Many of them pay dividends, too, which can be a comforting source of returns when the market's gone haywire.
You can invest in big companies individually, but it's easier to get quick diversification with an S&P 500 index fund or ETF. S&P 500 index funds replicate the performance of the S&P 500 -- a basket of 500 large-cap, U.S. companies. You can own a slice of all of them with a single S&P 500 index fund share.
There are many S&P 500 index funds out there. Their performance is usually comparable, in that you'll see returns that track with the index, less the fund's operating expenses. Since expenses do affect shareholder returns, you're wise to pick a fund with a very low expense ratio, like less than .1%. Otherwise, you're just paying more for a job someone else can do for less.
3. Try dollar-cost averaging
Dollar-cost averaging (DCA) is the practice of investing a set amount periodically in lieu of investing a larger amount at one time. The consistent, periodic approach lowers your risk of inadvertently mistiming a purchase.
Let's say you've budgeted $1,200 annually for your investment account. If you invest $100 monthly for 12 months, you'll be trading in a variety of market conditions. Sometimes you'll buy when share prices are lower, and sometimes you'll buy when they're higher. Those lows and highs should balance each other out, such that your costs never reflect market extremes.
Alternatively, you could invest that $1,200 all at once. You might get lucky and buy when the market is down. In that case, your cost basis will be lower and you'll end up with more shares for your money. But the opposite can happen, too. You could buy at a peak, the day before the market crashes. That would stink, right? If you'd rather play it safe, commit to a monthly buy instead.
4. Stay focused on the long term
Logically speaking, as long as you don't need your invested funds right now, what's happening in the market today shouldn't matter. That's easy to say and much harder to believe. But this fact might help: The long-term average annual growth of the S&P 500 is about 7% after inflation. If you want that 7% return -- and you definitely do -- you have to ride out market volatility. The more often you step in and out of your investments, the harder it'll be to reach that 7%.
Here's why that is. You'll sell when the market dips enough to make you nervous, and then you won't buy back in until a recovery is assured. In practice, that approach amounts to selling low and buying high. That math never works in your favor.
On the other hand, if you stay invested, you don't have to worry about when the market will recover. You just have to wait for it to happen.
Jump right in
The market outlook today may be sketchy, but the time is right to test your investing fortitude. Ease into it by padding your cash reserves, choosing stable companies or funds, and being consistent in your approach. Remember, too, that you're playing the long game. And the long game is one you can win.