the Nasdaq Composite exploded higher by 9% in just five recent trading days, knocking the index out of its brief period in a bear market. The index remains in correction territory, but the rebound is a great respite. But we are not out of the woods yet.
No one knows if the market will retest its 2022 lows. What we do know is that volatility remains high, and the month of March has been full of wide market swings with several big up and down days.
Given all the uncertainty, it is better to prepare for a bigger drop now than to be complacent and get caught off guard. Here are five questions to ask yourself in case the stock market keeps falling.
1. Why are you investing?
The stock market is nothing more than a playing field in which several different games are played simultaneously. Some people are day traders and don’t care about the fundamentals. Instead, his focus is on short-term price action and technical analysis. Others are trying to bet big on a shot at the moon. Some people are trying to beat the market over a time horizon of several decades. And many people simply focus on capital preservation or passive income generation in retirement. There’s a big difference between a Wall Street hedge fund with billions of dollars under management and an 18-year-old with $500 in extra cash they made over the summer.
Once you start to understand the different types of investors and their different motivations, it becomes easier to understand why stock prices can do crazy things. Put another way, knee-jerk reactions and market volatility become less surprising.
While it may be tempting to try to time the market, the best thing an investor can do is be right, choose good companies, keep a cool head, and let the power of patience and compounding returns do their work over time. These are tools that are free to use, yet many investors ignore them in favor of gambling.
2. What is your time horizon?
Your investment horizon is heavily influenced by age. But it can also depend on different financial obligations or future expenses. Some investors are in the asset accumulation phase, while others are in the asset distribution phase.
Younger investors who still have years of higher earnings and fewer financial obligations ahead of them can afford to take risks and can use decades of portfolio growth to their advantage. Investors approaching retirement, or any period when spending may start to outpace income, tend to be more focused on safeguarding their savings and protecting against downside risk. In this sense, an investor with a longer time horizon can afford to have a higher percentage of her assets in growth stocks while a retiree may be more interested in income of stable dividend payers.
3. What is your risk tolerance?
Looking at a chart of stocks that have beaten the market over the past few decades is a fairly simple exercise. But not all earnings are created equal. In fact, some of the best stocks have been extremely volatile and have required nerves of steel to hold onto for certain periods of time. For example, Amazon (AMZN 0.69% ) Stocks lost nearly 90% of their value in less than 18 months during the dot-com bubble burst in the early 2000s.
Between October 23, 2007 and November 20, 2008, Amazon also lost 65% of its value. And then between September 4, 2018 and Christmas Eve 2018, Amazon lost more than a third of its value. However, even if you bought Amazon stock at its peak just before the dot-com crash on January 3, 2000 and suffered those declines, you would still have a 3,500% profit at the time of this writing.
The lesson here is to understand your temperament and tolerance for risk. before buying a share. Investors who bought Amazon and panic sold missed out on some major gains. But the decision is too clear in hindsight and is never easy in the moment.
4. How vulnerable are you to volatility?
Volatility exposure combines your personal investment objectives, time horizon and risk tolerance. For example, a young investor who hates risk but is investing for decades to come may find himself with a higher stock allocation than a risk-tolerant investor who has some major purchases coming up or is nearing retirement.
Understanding your and your family’s exposure to volatility is a good exercise that can help you build a portfolio that’s best for you. Being vulnerable to volatility often means taking on less risk and allocating a higher percentage of your savings to cash and bonds rather than stocks, although stocks tend to outperform cash and bonds over the long term.
5. What type of investor do you want to be?
Most of us have our favorite investor role models. Some gravitate towards the characters of Michael Lewis. the big bet who correctly predicted the financial crisis and made money from it. Others appreciate the popular style of Peter Lynch or The patience and ironic wisdom of Warren Buffett. Some people want to be gunslingers and make bold bets. Others want to stick to what they know and invest in a way that helps them get a good night’s sleep.
At The Motley Fool, we try to foster the principles that will give you positive potential, encourage creativity, and give you a balanced overall approach. By doing your own research and maintaining a diversified portfolio that combines long-term advantages with proven winners, you can structure your investments in a way that suits your style.
This article represents the opinion of the author, who may not agree with the “official” recommendation position of a premium Motley Fool advisory service. We are motley! Questioning an investment thesis, even one of your own, helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.