Market Volatility: Invest Smart, Know the Risks

Investing into the market for retirement funds is a risky business. Retirees often purchase individual stocks or invest in financial products such as mutual funds, exchange-traded funds (ETFs), or even variable annuities. There are other options such as defined contribution plans that invest into stock market and sometimes a company’s stock. 401(k)s are a common option offered by employers with a matching percentage. Having various investments allows for a more diversified portfolio, leading to a better chance at the safe and secure retirement you have always dreamt of.

However, invest smart and know the risks: the financial markets have significant fluctuations. There is a huge chance of majorly reducing retirement funds due to a bad down in the stock market. Therefore, long- and short-term investments are encouraged.

With the roller coaster of the financial markets, timing is everything when it comes to withdrawing from retirement savings & investments. Unfortunately, what may happen with the return of these investments is more negative than anything to the investor. Meaning, more of the account or assets may need to be liquidated to ensure spending power and keep that consistent stream of income. This is called sequence of return risk. An example of this was with the 2008 Recession; where the market declined and many lost their homes, their other investments, their retirements. For those who have awhile to save and plan are able to likely recover loss. Retirees with less time or who need their income soon will have to sell their investment assets while the market is down to reduce further loss and keep that income. A great loss is encountered if assets cannot be recovered.

Diversification of these assets/investments is important. Individual assets, such as the mutual funds and ETFS, may be managed professionally. These funds may have a focus on small to larger companies, even with specific fields or industries in mind. For individually chosen stocks and annuities, consider stock investments. Within these various options, there are performance and choice risks. Investment for retirement funds is a choice that should be taken with research and guidance.

As mentioned, there is always risk with investing—especially for your dream retirement. The following are some great strategies to limit the risks.

Diversify. Hold various investments across the classes (i.e. hold bonds and stocks). The more spread out and full the investments are better at loss absorption your portfolio is. For example, loss in individual stocks can be offset by holding stocks in 15+ companies and balancing the funds throughout these. If you were to hold the same amount over 5 companies/stocks, you are exposed to a greater risk if one of those companies crashes versus if you have the funds spread over 15 or more. Even considering fixed income investments is great! These will not yield as much return, however.

Long term is best. With investments, time is typically on your side. Especially in the case of recovering losses. It is rare you will see recovery happen overnight—it takes years. Those near or in retirement will want to monitor their investments closely because if a major loss occurs, you may be better off selling. Top experts suggest relying on income-generating policies while moving funds from the stock market throughout your retirement years.

Roll with the pooled. Like carpooling to an event, a pooled investment is smaller contributions from individual to make a larger investment fund. Some examples are mutual funds and target-date funds. Oftentimes these are done with financial experts and there may be fees involved.

Remember fees. Higher fees do not necessarily mean a higher yield on investments. They reduce the overall return, so monitoring and understanding them is important for your financial wellbeing. 401(k)s and other defined contribution plans may have fees; sometimes a fee may be charged if using a financial advisor for advice and portfolio management.

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The Importance of Stock Bubble Stages

In context, a financial bubble is observed disbelief when prices increase, and stocks become overvalued. A bubble can pertain to individual stocks, an entire sector, market, or asset class. When the bubble ‘bursts’ stocks or assets are sold off and prices rapidly decline. The burst leads to a crash. While the collateral of the burst depends, it may spill over into other areas. For example, the U.S. dotcom bubble in 2000 and the 2008 real estate bubble bursts lead to severe recessions.

Stages of a Bubble

  1. Displacement begins when investors obsess over new ideas or opportunities such as technology. During these periods prices will steadily, but slowly, rise.
  2. Boom follows as the momentum from the displacement catches. While more people invest in the specific asset, widespread attention is brought upon it. The bigger the audience, the more people decide to invest because they want in on the success. As more investors invest even more follow.
  3. With prices still going up, euphoria reaches extremes that keeps a steep rise on prices. What plays out next is that people are fooled into still buying more.
  4. Fourthly, profit-taking begins when institutional investors take advantage of the warnings sign that the bubble is just before its bursting point. These investors begin selling first and take profit. However, predicting the exact moment of popping is difficult.
  5. Popping the bubble could be a major event or a minor jab at the bubble’s edge. Inducing panic, investors want to liquidate assets immediately at any price. This creates a supply that overcomes demand. Prices drop drastically quickly.

Causes of Bubbles

There are limitless ways bubbles can begin, especially in our global economy. The following are major historical influencers:

  • New products or technologies create demand which increases prices.
  • Supply shortages of an asset/item creating a climb in price.
  • Interest rates hit a low, encouraging borrowers to establish lines of credit or take out loans. This leads to increased spending and investing.
  • An uptake of foreign investors come in due to favorable opportunities.

When the Bubble Bursts

Bubble bursts can be triggers by major or minor events. Ultimately, inevitably, bubble must pop. The aftermath can be short-lived where little loss is experienced.

However, the worst-case scenario is a stock market crash leading to a recession (which could lead to a depression). What matters most is the size of the bubble—meaning small or specialized assets classes or bigger sectors such as real estate or tech. After size what matters most for impact is how much investment money is involved.

Debt-fueled bubbles can lead to long-lasting recessions. Our most recent example of this is the housing bubble pop in 2006-07 that jumpstarted the Great Recession.

How will this impact your retirement assets? Listen to The Retirement Risk Show episode “Cause and Effect: Stock Market Edition” where Dave Hall provides an in-depth analysis of the current market, discusses historic crashes and corrections, and speaks about what a market crash in the foreseeable future would mean for you retirement and how to protect your retirement assets before that crash does happen.

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