You should be investing for a reason or a goal. For most people, the reason is your retirement. If that is the case, this article may not help you. Your retirement is a long term event where you will have to continue to draw cash for 10, 20 or even 30 years.
This article is for those that are investing for an immediate goal such as
- Buying a house
- Buying a car
- Paying for a vacation
- College expenses
When you are saving for an event, your thinking about risk needs to transition from long-term to short-term. You need to start asking yourself if the benefits of the short-term gain start to become outweighed by short-term risk.
The market is not friendly, but it is rewarding. At any given time, we are probably only a few weeks from a series of events that will cause the market to correct by 10%. These events are not always foreseeable, and they may not even be rational. However, geopolitical events tied with earning reports of some specific companies could spook major investors and cause a correction. This is life as an investor. If you follow my advice in my book, The Confident Investor, you will eliminate much of your losses for these downturns but you won't eliminate all of those losses.
When the market suffers a loss, and you have followed my book's advice, you will suffer a small loss but will be in a position to grow your portfolio dramatically. My book teaches you to take advantage of these opportunities. However, those opportunities require a bit of patience and a bit of time. If you are saving for a specific expense like a new home, you may not have that time. If you are saving for retirement, you do have that time since your retirement will hopefully last for decades. Your house purchase though probably only has a realistic window of a couple months and maybe a couple weeks. Several months is not enough time to increase your profit after a market correction.
When the current short-term outlook potential is higher for a loss than an increase, you need to preserve your capital. You cannot tolerate a loss as much as you can tolerate not earning another 1-2% on your investments. If the market drops 10%, then you won't have time to make that up before you need the cash. If the market continues to increase, it will only increase 1-2% in the short term.
If you are six months away from making a major purchase such as a house or a car, your likely gain on that capital is probably 6-10% for the half year. If a market correction happens, your loss is likely to be 5-10% depending on your diligence of following the indicators. That gain is approximately equal to the loss. However, the loss may cause you to not afford the purchase. In this case, you need to lock in your cash so that you can afford the expenditure. If your purchase timeframe is longer, it may make sense to continue to ride the market.
As you get closer to your expenditure date, pull your investments into cash. You are no longer in "long term" mode, and you are now in "short term" mode. The pain of a small correction may be very large for you. Don't be afraid to protect your gains to achieve your goals.