Investing in the stock market is not for the faint hearted. You will come across periods where the stock prices move up and down like a roller coaster. The abrupt dips in the stock prices and slow uncertain rides up can create tremendous strain on your heart. Just when the market seems to stabilize, the prices go into free fall again. During this time, emotions and stress levels run high and it is easy to make emotional decisions that one may regret later. It is vital to stay level headed if you are going to remain invested. Sounds easier than it is? Here are 7 tips to help you get through the turbulent stock market.
1. Buy Companies You Have Done Research On and Feel Comfortable With
Buy only stocks that you are familiar with and comfortable with. You should understand the business and have done enough analysis on the company fundamentals and financials. When you are familiar enough, you will know when the stock is undervalued and when the stock is overpriced. That way, it will not matter to you how much the stock price falls; because it becomes cheaper and you may add more to your position instead. Investing should never be done on rumours, hearsay or news; it should be done on the basis of your own stock research.
2. Buy Blue Chip Dividend Stocks
Stick to Blue Chip Dividend Stocks, which is what I do. Big corporations with diversified businesses around the world are less likely to suffer significantly from a slowdown in the US alone. Such Companies include Coca-Cola, McDonalds, Microsoft, Procter and Gamble, Johnson & Johnson. These brands are well recognized globally and as such command a huge premium just due to their brands alone. They also have wide economic moats from their brand equity, economies of scale and more. Such companies are also cash rich and have excellent financial fundamentals as well as growth potential. They are very stable, have consistent Dividend policies and have a good track record of raising Dividends. Coca-Cola, a Warren Buffet favorite has declared the 49th consecutive annual dividend increase. In fact, these companies have outperformed the Dow Jones Index and S&P Index consistently in turbulent times.
3. Avoid Unnecessary Leverage and Buying on the Margin
Do not bet with borrowed money! While leverage can be a nice instrument to use to amplify gains in a bull market, it can be very destructive to your portfolio in turbulent times like these. For example, if you take on a 10% margin on a stock you own, a 10% drop in price would wipe out your stock holding entirely. Do not respond to margin calls as it is merely tossing more money down the drain. It doesn’t matter how fundamentally strong a Company is, if the market sentiment is down, the stock price goes down. A person using borrowed money to invest will not have the holding power to weather the price volatility.
4. Don’t Invest What You Cannot Afford to Lose
Investing books and investment advisors always have some general advice about how one should be invest in x proportion cash, x proportion equities and x proportion fixed income based on age group, risk aversion etc. However, this is just general guidance which does not take into account individual needs. Don’t invest the money which you are saving towards for a wedding or buying a house into equities! If you have no immediate needs such as buying a house or having children, you can safely invest more money. Investing in equities is inherently risky in the short term and there is no assurance that you will be able to sell and recover your money without any losses when you need to. When you are investing with money you cannot afford to lose, you will most likely suffer from stress, heartaches and sleepless nights when the market tanks. A general rule of thumb is if you are going to need that money in 5 years’ time, don’t invest it into the stock market; go into fixed income instead.
5. Setup a Stop Loss Strategy
It’s always better to cap your losses early, since it takes a larger gain to cover your losses. For example, a 50% loss requires a 100% gain on the capital that is left over to break even. A Stop Loss Order is a mechanism which most brokerages offer, which automatically sells your stock if the Stock Price hits your Stop Loss criteria such as 10% down. Stop Loss Strategy is a useful way to take the emotion out of the selling and automatically monitor your portfolio when you are on holidays and such. This strategy also allows you to cap your downside, but benefit from any amount of upside. Cutting loss offers you a piece of mind and lessens stress in a financial downturn where Stock Prices go down tremendously. Holding a huge losing position while waiting for an economic recovery can be quite harmful to your health. It may take a long time to breakeven. Furthermore, this strategy also prevents you from being a victim of a Stock which becomes bankrupt like Enron, Lehman Brothers and Bear Stearns.
6. Create a Cash Reserve for Emergencies
Before investing, you should always to put aside some cash for emergencies. Emergencies can happen any time and when it is most unexpected. An employee who is laid off may require anywhere from one month to six months to look for a new job. One may be hit by an accident or illness rendering him/her unable to work. Therefore, the suggested time frame for a cash reserve is at least six months of basic expenses. That way, one should feel pretty secure and also be more likely to stay level headed when the economy outlook is bad.
7. Never Invest 100%! Always Have Extra Investible Cash on Hand
Every downturn presents an opportunity to acquire undervalued blue chip stocks. However, if you are already fully invested with the money you have set aside for investing, you may not be able to capitalize on the opportunity. Either that or you may end up using your cash reserves. When that happens, you will feel stressed should the market continue to fall. The stock market can always fall lower no matter what the charts, analysts or company fundamentals tell you. So be patient and wait for compelling valuations, even then invest in small bite sizes.
If you are financially disciplined, do your research and set aside your cash reserves, the stock market turmoil would prove to be more of an opportunity to you rather than a party pooper.