What’s an investor to do?
The S&P 500 Index fell about 34% from its February peak to the market’s March 23 bottom. Since then, it’s back up about 58%.
I’ll share the answer to that question in a moment. But first, we have to address the most important prerequisites you must meet before putting any money to work in today’s unusual market…
You see, investing in riskier assets like stocks and corporate bonds should never be the first step you take in building wealth and establishing financial freedom. It should be one of the last.
All investors – and I mean all – must go through these mission-critical preparatory steps first…
1. Clearly define your investment goals.
It seems so obvious, and yet most folks I speak with skip right over this first step. By and large, all investors are looking to do just three basic things…
- Get wealthy.
- Stay wealthy.
- Generate steady, current income.
First, identify which of these goals are yours and then invest accordingly. Stocks, for example, can help you get wealthy… Hedges and hard assets can help you stay wealthy… And bonds and dividend investments can help you produce safe, steady income.
This next step is also an important part of choosing between these priorities…
2. Know your investment horizon.
The length of your investment horizon will have more of an impact on how you should be investing than you probably realize. Put simply, the shorter your horizon, the less risk you should take in your portfolio.
That’s because assets with the highest return potential (like microcap stocks or extremely distressed debt) also tend to be the most volatile. Over the longer term – more than five years – these risky assets tend to outperform. But over shorter periods, they can massively underperform.
So if you only have a few years before you’ll need the money, you’ll have to reduce your risk and tilt more toward “stay wealthy” investments.
3. Understand your risk tolerance.
This step requires you to be completely honest with yourself.
Do you really have the temperament to stomach the extreme short-term losses that investing in risky assets will bring? If you’re comfortable zig-zagging your way to big-but-volatile investment gains, invest in riskier assets. But if you prefer sleeping well at night, pick safer vehicles.
4. Clean up your “personal balance sheet.”
This might be the most important prerequisite to investing. And yet countless folks with student loans and credit-card debts are avoiding it. In short, before you put real money into any stock or bond, you must first pay off your high-cost debt.
Given where markets and prevailing interest rates are today, I suggest you use this rule of thumb… List any and all debts you owe that carry an annual interest rate of 6% or more.
First, look to consolidate and refinance these debts to a rate below that threshold – rates for residential mortgages and home-equity loans have never been lower. But for those debts you cannot refinance, pay them off… before you buy even that fractional share of Apple (AAPL) you’ve been eyeing on your Robinhood trading app.
So what’s an investor to do today? It largely depends on these four mission-critical steps – and where you stand on them.
If you’re primarily looking to stay wealthy… if you have an investment horizon of less than five years… if you can’t stomach big short-term losses… or if you currently owe debts with interest rates of 6% or more – you should not be investing in the stock market today. Full stop.
If you do have your financial house in order, now is a good time to invest – as long as you use caution.
Hold more protection and “rainy day” reserves than normal… And only buy the best kind of stocks. That means owning high-quality, rapidly growing companies with enduring franchises, talented management teams, and high returns on investment.
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Source: Daily Wealth