There’s no doubt that the stock market has been a bit turbulent these past few days. After days when the stock market tumbles, the financial news media claims the double dip recession is here, and after days when the Dow and S&P shoot back up, stories point to the rally in 2008 that took place right after the biggest drop as a comparison.
This type of volatility is sure to scare investors away from stocks. Wise advisers have warned that if you can’t handle these day-to-day swings without loosing sleep at night, you shouldn’t be invested in stocks in the first place. It’s the risk of these swings that helps stocks earn long-term impressive returns compared to inflation.
If you’re losing sleep and have come to the realization that your risk tolerance is lower than you thought it was when the market was soaring high, your gut reaction is to get out of risky stocks and invest in bonds or nothing at all. Then after growth in stocks seems to be accelerating again, jump back on the bus (usually when it’s too late to take advantage). The long-term returns of the stock market relies on being invested at the lows, so selling low and buying high will ensure your investments will never perform at the advertised long-term returns.
Warren Buffett is buying more stocks right now, according to an interview with Fortune magazine. To run scared from a volatile market is not a good way to grow your wealth. Rather than come to the realization that you’ve overestimated your tolerance for risk, investors should embrace this time as an opportunity.
Losing sleep over day-to-day stock performance is not a result of a low risk tolerance that signals stocks are not the right investments. Stocks are the right investments, and people have to realize that this volatility is part of investing. If you run away, you lose. If you’re losing sleep, start viewing declines as an opportunity to double down and buy into the stock market when you can.
As people age, however, this volatility does become much more important. A stock market crash at the same time you need your money can undo many years of great performance. For this reason, it might make sense to gradually decrease exposure to stocks as you get older, but not too much. Even at the typical retirement age, you’ll still likely have many years to live and to let your wealth grow further.
Rather than investing in the stock market as a whole, building wealth can be much faster if you take Warren Buffett’s approach and invest directly in businesses. Whether it’s providing capital directly or investing in specific stocks, this takes significant research and work to do correctly. The risk is much greater — you could lose all your money — but the potential benefit is also much greater. This isn’t the right approach for everyone, but if Buffett is in buying mode, you should be, too.
Are you seeing this volatility as an opportunity or are you moving away from stocks?
Published or updated August 12, 2011.