The U.S. stock market had a banner year in 2019. The S&P 500 gained more than 28%, the Nasdaq jumped 35%, and the Dow Jones Industrial Average rose 22%.
Will 2020 deliver another great year for investors? It’s impossible to know for sure. However, you can set yourself up for ongoing stock market success by following these three tips.
1. Develop an investment strategy
It is not difficult to develop an investment strategy. You need to answer a few basic questions to get started:
- How much money do you have to invest (or do you have invested currently)?
- What is the annual rate of return that you seek?
- What is your investment time horizon?
- What is your risk tolerance (i.e., capacity to withstand a loss of capital)?
- Do you anticipate a need to tap into these funds in the short or medium term? This could force you into distress selling.
Honest answers could guide you to investment vehicles best suited for your unique mindset, situation, and station in life. Investors with high risk tolerance and who seek a high rate of return may choose to invest in growth stocks. Those whose risk tolerance is moderate and wish to seek modest but steady returns could invest in income stocks. Investors with very low risk tolerance, especially those nearing retirement, could choose to invest in certificates of deposit (CDs) and triple-A rated bonds (corporate, municipal, or government).
One rule of thumb is that the higher the desired rate of return, the greater the risk of loss. Another rule of thumb is that your propensity for loss is inversely proportional to your age. However, there could be exceptions. Consider articulating your investment strategy and quantifying the expected rate of return, so that you can measure your actual performance.
2. Build a portfolio of investments
Once you have defined your investment strategy, start building your portfolio of investments. This usually starts with saving money regularly and putting it into investment vehicles best suited for you. These could include stocks, mutual funds, real estate investment trusts (REITs), and exchange-traded funds (ETFs), each of which is associated with varying levels of risk and returns.
As you build your portfolio, consider the cardinal rules of investing, including:
- Put your money in assets and businesses that you know and can trust.
- Build a portfolio of different asset classes with varying levels of risks and returns to minimize the overall risk.
- Don’t put more than 5% of your total investments into any one security to mitigate the risk of loss from one or more bad investment decisions.
- Minimize your investment expenses (i.e., commissions and fees.)
- Leverage the benefits of compounding. Many public companies offer dividend reinvestment plans (DRiPs) where shareholders can automatically reinvest cash dividends into additional or fractional shares of the company.
3. Steel yourself against market volatility
Volatility refers to the gyrations of the stock markets, which can vary in frequency and intensity. The best analogy of volatility is the turbulence one may experience during an airplane flight. Imagine jumping off the plane every time the plane hits an air pocket or encounters “thermal turbulence”. But that is precisely what individual investors are wont to do.
Stomach-churning volatility often causes individual investors to panic and bail, abandoning carefully planned investments. The best way to deal with volatility is to identify events likely to cause it, anticipate their likely impact, and develop plans to deal with it. This should minimize knee-jerk reactions, and it represents risk management at the micro level. However, this isn’t a silver bullet as you may not be able to anticipate every single event that could cause stock market volatility.
What could cause stock market volatility in 2020? There are plenty of potential factors, including:
- An attempt by the Chinese government to put down the unrest in Hong Kong with overwhelming force
- A severe slowdown in the global economy
- Q4 earnings of U.S. companies falling short of expectations
- U.S. Federal Reserve changes to its benchmark interest rate
- A strongly left-leaning candidate winning the Democrat party nomination for the U.S. presidential election (which could especially impact the healthcare and banking sectors)
Achieving your goals
The strategies and tactics outlined above should help you ignore the noise and achieve your investment goals by staying invested for the long term. As financial author Andrew Clarke, CFP, has noted: “A successful investor has a good knowledge base, a well-defined investment plan, and nerves of steel to stick with it.”