This is why you should never go all in on the stock market

With the cooling of inflation and the Nasdaq composite With a recovery of more than 20% since the lows in June, it may look like the worst sell-off in 2022 is in the rearview mirror. However, the Federal Reserve is still a long way from its long-term inflation target of 2% (inflation is currently at 8.5%). In addition, geopolitical tensions are ongoing and, arguably, rising. Higher energy costs could become the new normal due to years of underinvestment in the oil and gas industry and limited global supply.

At the same time, unemployment is at its 40-year low, consumer spending is high and the US economy continues to benefit from a diverse mix of sectors, from energy, technology and healthcare to some of the world’s most recognized consumer markets. brands.

When there’s a mixed bag of macroeconomic data and big gaps between better-than-expected gains and outright disaster, there’s a good chance there will be phenomenal buying opportunities in the stock market. As tempting as it is to double or triple when a stock is on sale, it’s never a good idea to go all-in on the stock market. Here are three reasons why.

A person looks up and smiles while holding a notebook in a library.

Image source: Getty Images.

Maintain an emergency fund

Financial Planning 101: Always have an emergency fund in case unexpected costs arise, such as health problems, loss of income or any number of unforeseen costs. It is recommended that a person keep three to six months of expenses in an emergency fund. However, it is much safer to keep six months of income in an emergency fund, as it produces a larger nest egg.

The last thing an investor should do is draw on an emergency fund to buy stocks on sale. One of the worst-case scenarios would be to use an emergency fund — or money that would have to be set aside to build one — to invest in the stock market, only to run into an emergency and have to sell stocks cheaply to save the day. cost.

Avoiding a high-pressure portfolio

An emergency fund is useful no matter how the stock market is doing. But in bear markets, an emergency fund can do wonders for the psychological aspect of investing.

One of the easiest ways to lose money in the stock market is to put undue strain on your portfolio by investing too much in one company or by making the portfolio large enough that volatility is putting more stress on your life. Managing a low-stress portfolio with the right size, weights and allocation ensures that even if the stock market crashes, you can stay calm and ride it out.

One of the main reasons people miss out on multi-decade composite returns is that they sell when the fear is high and don’t buy back when the market picks up again. By holding a diversified portfolio that’s aligned with your personal risk tolerance and investment goals, you’re more likely to weather volatility when others rush for the exit.

US inflation chart

US inflation data by YCharts.

Focus on long-term profits rather than short-term trades

The stock market is a long-term wealth creation machine. But no one knows how it will perform in the short term. Investing what you can’t afford to lose or have to spend in a year or two is not a good idea.

For investors with an emergency fund and a lot of cash on the sidelines that they don’t need for the time being, going all-in on the stock market can still be a bad idea. Coming back to our previous two points, some of the worst mistakes are made when an investor overcharges on one stock or one sector. In that case, it can be tempting to take a profit if the position only rises a little because there is so much on the investment.

Grow your money while maintaining peace of mind

In my opinion, the best investors are not those who pick the best stocks, but rather those who pick good stocks and can remain stable through market cycles and periods of high volatility. Having a significant emergency fund, managing a low-pressure portfolio, and focusing on long-term gains on short-term trades are three tools that can do wonders for your temperament and make it easier to stay focused on your long-term financial goals.

Regardless of your portfolio size, time horizon or risk tolerance, going all in on the stock market makes an investor highly vulnerable to the short-term vagaries of the stock market and can even jeopardize one’s financial health if the market stays low for longer than expected.

Daniel Foelber has no position in any of the listed stocks. The Motley Fool has no position in any of the listed stocks. The Motley Fool has a disclosure policy.

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