The stock market has been something of a roller coaster in 2022. Unfortunately, unlike on a real roller coaster, the downs in the stock market are a lot less fun for long-term investors than the ups, and we've certainly had plenty of downs so far this year.
That raises a key question: Given that crazy volatility, is it safer to pull your money out of the stock market or to keep investing for now? As with most questions about the market, there really isn't a one-size-fits-all answer. Still, if nothing else, the market's recent moves show that it's important to get your own financial house in order.
Why your own financial picture matters when it comes to investing
A falling stock market is often accompanied by job losses. This is at least in part because many companies use stock as a form of currency -- exchanging it for cash or using it instead of cash in order to pay for their expansion. When the market falls, it gets harder to justify using stock that way, which ultimately reduces investment in expansion.
That often results in job losses. After all, people who were hired or contracted to deliver on expansion projects aren't needed if the expansion isn't going to happen. Even if a business spreads those expansion projects among its existing staff, if those projects go away, jobs become vulnerable.
If, as a result, if you find yourself out of a job at the same time that your investments are down, you can wake up in a world of financial hurt if you're not prepared. After all, your bills don't go away just because your income does. If the only way you can pay those bills is by selling your stocks while they're down, you'll have that much less invested to participate in any market recovery that may occur.
So what does a solid financial picture look like?
There are three parts to a solid financial picture: debt control, an emergency fund, and a reasonable time horizon. For debt control, it's really important that you pay off nearly all your debts. About the only ones that it may make sense to keep are the ones for which all three of the following factors are true:
- It's at a low interest rate -- either interest-free or a low-single-digit rate.
- It has a reasonable payment -- low enough that you can make the payment without seriously crimping your lifestyle.
- It serves a key purpose for your future -- such as giving you a place to live, a way to earn a living, or a means to keep you alive.
Using the debt avalanche method to pay down all other debts can help you reduce your debt load fairly quickly.
Once your debts are under control, building an emergency fund of three to six months of expenses can help you if you find yourself without a job while the market is down. No, you can't outlast an extended job loss with just a six-month emergency fund, but you can typically buy enough time to at least get some alternative source of income coming in.
On a somewhat related note, it's important to have an appropriate time horizon for any stock investments you make. Money you expect to need within the next five or so years does not belong in stocks. This is because stock market returns are never guaranteed. With a five-year time horizon, you at least give yourself a fighting chance of seeing positive returns before you need to cash in your stocks.
If those pieces are in place, now can be a great time to invest
As long as the rest of your financial house is in order, now can be a much better time to invest than when the market was at its all-time highs. After all, thanks to the recent stock downturn, every dollar you invest can buy that many more shares of the same great companies you could have bought at a higher price earlier.
Of course, there are still no guarantees that the market will recover quickly, but if your overall financial house is in order, it gets that much easier for you to wait things out. So make today the day you commit to getting that solid foundation in place. That way you can invest even in volatile times for the potential to receive stronger long-term returns.