The stock market has staged an epic rally in the last week or so. Then briefly down more than 20% year-to-date (YTD)the Nasdaq Composite it is now down less than 10% YTD. Similarly, the S&P 500 and the Dow Jones Industrial Average both are down less than 5% YTD and are officially out of correction territory.
With the market processing rising interest rates, the prospect of lower inflation, and improving geopolitical risks, now is the time to go all out on the stock Exchange? Or is there a better alternative?
be greedy when others are fearful
Warren Buffett, CEO of Berkshire Hathaway (BRK.A -0.22% )(BRK.B -0.29% ), is known for its long-term track record of beating the stock market. But he is also known for one of the most famous quotes in investing, which is “to be fearful when others are greedy and greedy when others are fearful”. It’s a strategy that tends to keep investors out of trouble, both by recognizing when a stock is overvalued and by taking advantage of buying opportunities.
In the last four years, there have been three big sell-offs. At the end of 2018, a brief bear market occurred almost entirely in the last three months of the year. Fears over the US-China trade war crushed investor optimism and caused a lot of fear and volatility. But it turned out to be an incredible buying opportunity, as the S&P 500 proceeded to make big gains in 2019.
The next big sell-off was the COVID-19-induced crash in the spring of 2020, which also turned out to be a buying opportunity that led to massive gains for the rest of that year and for most of 2021. The third sell-off is the we are still in now. And if history continues to repeat itself, it will probably prove to be a fantastic long-term buying opportunity as well.
Expect the unexpected
You may be wondering: if now is a good time to buy, why not go all-in on the US stock market? Well, that’s a bad idea for several reasons.
For starters, it’s important to have an emergency fund in case unexpected medical expenses or unforeseen crises arise. Although the stock market has been a great vehicle for fueling wealth creation over time, no one knows how it might work in the short term. The market has staged an epic rebound, but could give up all of those gains for any number of reasons, including tighter monetary policy, a worsening geopolitical situation, or an infinite number of unknowns.
Going hard into the stock market without reserve dry powder leaves you too exposed to short-term volatility. By putting money to work in the stock market that you don’t need in the short term, you can ease the pressure of short-term gyrations and keep a level head in case the market sell-off resumes.
a better approach
Yes, it sounds boring. But the best approach to investing is simply to average the dollar cost of a portion of your stock income over time. That’s the classic advice, anyway. Of course, an investor can trade with a little more wiggle room by holding a fixed amount of cash on margin that he only hopes to deploy if there’s a really juicy buying opportunity. In that scenario, it would make sense to start looking at some of the many stocks that are for sale now.
selective purchase big companies going up for sale is a strategy worth combining with dollar cost averaging. In this sense, an investor can take advantage of a sort of hybrid passive/active approach that leaves room for discipline and creativity.
Navigating the volatility
Even if the market does not retest its lows and continues to rise in 2022, it is likely to see further corrections and bear markets in the coming years. Timing the market is difficult, and short-term price movements can be random, confusing, and based on nothing to do with fundamental business.
Understanding that the market can do crazy and unpredictable things can help keep emotions in check during a stock market sell-off, as well as calm the urge to go all-in, even when it may be tempting to do so.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium 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.