Step 11: Investing in the Market
I thought it would be helpful to share my rules of thumb for who should invest and who should not.
First: let's review the basic reason any of us might consider investing: Over the long term (and, my friends, I mean 10, 20, or 30 years) stocks have, on average, produced strong returns of about 10 percent. That means stocks may be down 10 percent one year, up 20 percent the next, and the down 5 percent the next. There are no smooth rides or guarantees, but there is the historical pattern. That's why we all should consider investing in stocks. But notice I said "consider."
Here's my list of when it does not make sense to invest in the stock market. If you...
don't have an eight-month emergency cash fund.
are paying off a car loan or credit card debt at an interest rate of 6 percent or more.
will need the money in less than ten years.
don't have a stomach of steel.
And you have to be sure about that last point. Between its high in 2000 and October 2002, the NASDAQ index—which represents a lot of the big technology stocks—fell 74 percent. How's your stomach feeling now? The index would have to gain 9 percent a year for 15 years to get back to even. That's why you want to have the time to weather downturns and to profit in up markets.
Keeping Ahead of the Market
To help you avoid experiencing those huge losses, let me share another favorite rule of thumb: If you make a lump-sum investment and it falls 8 percent, sell and reinvest the money in another (hopefully better!) stock or mutual fund.
If the trend of the market is down, keep the money in cash until it begins to rally. This rule doesn't apply to those making regular investments in a 401(k), 403(b), or your own self-enforced savings plan. What you're doing in those cases is dollar cost averaging (DCA): Rather than investing $12,000 on January 1, you invest, say, $1,000 each month. That means sometimes the $1,000 will buy more shares—if the market has fallen—and sometimes it will buy fewer shares. So if you're committed to a DCA program, don't worry about the 8 percent rule. Just keep up the investing.