After yesterday's market plunge, I know what you're thinking: Here we go again.
Monday's 200-point drop in the Dow may not mark the end of the stock market's three-month rally, but it has certainly reminded investors that stocks don't move straight up forever. And although some readers have used the respite that the rally provided to assess their risk tolerance and make moves to get their portfolios back in shape, I'll bet that plenty of you wanted to ride the bull as far as it would take you before reining in your investment risk.
But after some big gains recently, many investors feel stuck between a rock and a hard place. They know they need to take risks in order to reach their financial goals, but the volatility of stocks -- especially recently -- has them wondering if they have the discipline to stick with their investing plans.
Fighting money panic
That's the concern that Foolish retirement expert Robert Brokamp addresses in his mid-month update for subscribers to his Rule Your Retirement newsletter. When you have short-term goals that you need money to cover now -- whether it be a down payment for a home, putting kids through college, or getting ready to retire -- you can't afford to take the same risks that you do for longer-term goals.
But when you look at all your investments in a single portfolio, even normal market fluctuations can make you nervous. For instance, if you have $10,000 in cash set aside for some immediate need, and you have a net worth of $200,000, all it takes is a 5% swing in your portfolio to lose that entire $10,000. And even though the loss doesn't make the cash actually disappear, it can definitely make you feel anxious about parting with that money.
Don't kick the bucket
Robert advises an easy way to help you beat these anxieties and spend what you need to, while keeping your investment strategy intact. By separating your money into discrete "buckets" for different purposes, you can stay confident that you'll be able to meet your immediate needs while staying on track for long-term goals like retirement.
Here's a simple example of how such an approach might work in real life. Say you need to send your child to college in three years and will need $100,000 spread over four years. You also plan to retire 15 years from now. If you have $300,000 in your investment portfolio, here's how the bucket strategy might work:
- The college bucket would largely be invested in short-term savings vehicles like CDs and money market accounts. But with six to seven years before you'll need to pay tuition for your child's senior year, you can afford to have some conservative stocks in that bucket as well -- stocks like Wal-Mart (NYSE:WMT) or McDonald's (NYSE:MCD), for instance, that combine reasonable value with the backing of dividends.
- In contrast, your retirement bucket would include your more aggressive investments -- companies in recently volatile sectors, like PotashCorp (NYSE:POT) and Bank of America (NYSE:BAC), for example, along with small growth stocks such as China Natural Gas (NASDAQ:CHNG).
By creating two buckets, you can use the appropriate strategies to meet each goal you have. When higher-risk stocks like biotech test specialist Sequenom (NASDAQ:SQNM) or energy producer Western Refining (NYSE:WNR) take big hits as they have recently, you'll still lose the same amount of money. But because it will be isolated in your long-term bucket, you don't have to worry that it'll have an impact on shorter-term needs.
Be ready
Market volatility isn't going anywhere. But while you can't control the market, you can control how market moves affect you. If the prospect of further losses has you worrying about your financial future, try out the bucket approach -- it should help you stay on course.
Learn more about investing for retirement and beyond:
- Do this if you want to retire anytime soon.
- Don't buy into these investment myths.
- This move could save your retirement.
