Over the last few months, the stock market has experienced extreme volatility. Both the S&P 500 and the Dow Jones Industrial Average closed out one of their worst quarters in history earlier this year, and millions of investors may have watched their retirement account balances plummet during this time.
However, the stock market is currently in the midst of a spectacular comeback. On the same day that the National Bureau of Economic Research announced that the U.S. is officially in a recession, the S&P 500 recovered its losses and turned positive for the year.
This comeback doesn't seem to make sense. The country is in a recession, many states are experiencing spikes in the number of COVID-19 cases, and the U.S. is experiencing nationwide civil unrest. By many accounts, the stock market shouldn't be seeing the growth that it is. But the market plays by its own set of rules, and even the most experienced investors can't always explain why it does what it does.
That can be intimidating, especially if your life savings are tied up in the stock market and your future depends on how your investments perform. But here's the good news: No matter how wild the market gets, it may not actually matter.
Investing is playing the long game
Investing in the stock market is more about building long-term wealth than earning short-term gains. Even during strong economic times, the market will still experience ups and downs from year to year. Over the long run, however, you'll typically see positive returns on your investments.
You may be tempted to try to time the market, investing more when the market is gaining speed and then pulling your money out right before a crash. While this plan sounds good in theory, it's nearly impossible for even investing experts to time the market -- especially right now, when the market doesn't make much sense. There's a good chance there will be another market crash in the future, but nobody knows exactly when that will happen. So trying to time your investments perfectly without losing money will be an extremely challenging task.
One of the best things you can do for your money is to simply leave your investments alone and ride out the storm. Historically, the stock market has bounced back from every downturn it has faced. There could be another crash on the way, but if that happens, your savings will recover as long as you let the market run its course and leave your investments alone as much as possible.
There's nothing you can do to change the stock market's performance, and if you get caught up in the day-to-day ups and downs, there's a greater chance you may make a decision that hurts your savings over the long term.
What if you're nearing retirement age?
If you're getting close to retiring, you may be especially concerned about the stock market's volatility. After all, if the market crashes immediately before you're set to retire, that could potentially throw off your plans. In addition, you won't have as much time to let your savings recover compared to younger workers who are still decades from retirement.
However, there is a way to limit your risk in the event of a market downturn, and it has to do with asset allocation. Asset allocation refers to how your money is divided up between stocks, bonds, and other securities. The more money that's invested in stocks, the riskier your portfolio is -- and the more likely you are to see your investments plummet during a market crash.
When you're young and still have plenty of time before retirement, you can afford to be riskier with your investments because you have years to let your savings recover. But as you get older, your portfolio should gradually be getting more cautious. Bonds and other "safer" investments don't earn such high rates of return as stocks, but they're also less risky. As you get closer to retirement and invest more conservatively, your investments likely won't grow quite as quickly, but your money will be more protected from market crashes.
Exactly how much you should invest in stocks versus bonds depends on your age, when you plan to retire, and your overall tolerance for risk. It's still a good idea to invest some money in stocks no matter what, because that will help your investments grow more than if you're invested entirely in bonds. But in general, the older or more risk-averse you are, the more conservative your portfolio should be.
These are uncertain times for investors
The stock market has always been volatile to some degree, but these last few months have been an especially wild ride. Nobody knows what the future holds, which can be concerning to investors. However, by staying the course and keeping your money invested regardless of what happens, you'll come out the other side financially stronger.