With inflation cooling down and the Nasdaq Composite rebounding by over 20% since its June lows, it can seem like the worst of the 2022 sell-off may be in the rearview mirror. However, the Federal Reserve is still a long way from its long-term inflation target of 2% (inflation is currently 8.5%). What's more, geopolitical tensions are ongoing and, arguably, rising. Higher energy costs could be the new normal due to years of underinvestment in the oil and gas industry and limited global supply.
Yet, at the same time, unemployment is at a 40-year low, consumer spending is high, and the U.S. economy continues to benefit from a diverse mix of sectors, from energy, technology, and healthcare to some of the world's most recognized consumer brands.
When there's a mixed bag of macroeconomic data and wide gaps between better-than-expected earnings and downright disasters, chances are there will be some phenomenal buying opportunities in the stock market. As tempting as it may be to double or triple down when a stock is on sale, it's never a good idea to go all-in on the stock market. Here are three reasons why.
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Keeping an emergency fund
Financial planning 101: Always have an emergency fund in case unexpected expenses arise, such as health challenges, income loss, or any number of unforeseen costs. It's recommended that a person keeps three to six months of expenses in an emergency fund. However, it's much safer to keep six months of income in an emergency fund because it provides a larger nest egg.
The last thing an investor should do is draw from an emergency fund to buy stocks on sale. One of the worst-case scenarios would be to use an emergency fund -- or money that should be earmarked to build one -- to invest in the stock market, only to encounter an emergency and have to sell stocks on the cheap to afford the expense.
Avoiding a high-pressure portfolio
An emergency fund is helpful regardless of how the stock market is doing. But in bear markets, an emergency fund can do wonders for the psychological aspect of investing.
One of the easiest ways to lose money in the stock market is to add unnecessary pressure to your portfolio by investing too much in one company or making the portfolio large enough that volatility adds stress to your life. Operating a low-stress portfolio with proper sizing, weightings, and allocation ensures that even if the stock market crashes, you can remain calm and ride it out.
One of the main reasons people miss out on multi-decade compounded returns is that they sell when fear is high and fail to buy back in when the market rebounds. By keeping a diversified portfolio that is aligned with your personal risk tolerance and investment goals, you stand a better chance of enduring volatility when others are running for the exits.
US Inflation Rate data by YCharts.
Focus on long-term gains over short-term trades
The stock market is a wealth creation machine over the long term. But no one knows how it will perform short term. Investing what you can't afford to lose or will need to spend in a year or two isn't a good idea.
For investors with an emergency fund and a lot of cash on the sidelines that they won't need for some time, it could still be a bad idea to go all-in on the stock market. Going back to our previous two points, some of the worst mistakes are made when an investor loads up too much on one stock or one sector. In that event, it can be tempting to take gains if the position rises just a little bit, as there is so much riding on the investment.
Grow your money while sustaining peace of mind
In my opinion, the best investors aren't those who pick the greatest stocks but rather those who pick good stocks and can stay even-keeled throughout market cycles and periods of high volatility. Having a sizable emergency fund, operating a low-pressure portfolio, and focusing on long-term gains over short-term trades are three tools that can do wonders for your temperament and make it easier to stay focused on your long-term financial goals.
Regardless of your portfolio size, time horizon, or risk tolerance, going all-in on the stock market makes an investor highly vulnerable to the short-term whims of the stock market and could even jeopardize one's financial health if the market stays down for longer than expected.
