In this post, we will discuss how to invest during times of uncertainty. Before we start, here’s our disclosure:
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Expect the Unexpected
Since the year 2000, we have witnessed a great deal of turmoil and upheaval. It started with the dot-com bubble and later the 9/11 attacks, leading to the United States getting involved in prolonged wars in Afghanistan and Iraq. In 2020, the COVID-19 pandemic brought the world to a standstill, followed by the Russian invasion of Ukraine and conflict in the Middle East.
Then there were the natural disasters. Indonesia was hit by a devastating tsunami in 2004, followed by Hurricane Katrina in New Orleans in 2005, and another tsunami in Japan in 2011.
Between all of these events, the world was hit with one of the worst economic crises in generations.
In 2008, the housing bubble, created by banks making subprime loans, popped, resulting in the Great Recession. Unemployment skyrocketed, investment portfolios were cut in half, and many people faced foreclosures. It was the worst economic downturn since the Great Depression.
Uncertainty is the name of the game
Who could have predicted these events when celebrating the turn of the century on January 1st, 2000? No one. There is not one person out of the billions of people in the world who could have predicted these events.
Economic and global crises are not unique to the 2000s. Past decades have had their share of turmoil, with life and the economy experiencing many ups and downs. The future will be no exception, and there will be times when your investments go down. It is impossible to avoid all losses.
You may not have control over what happens in the world, but you are not powerless. You can prepare yourself to withstand economic upheavals and even profit from them. The key is to adopt a long-term investment strategy that you can stick to during market volatility. And the first step towards achieving this is to have the right mindset.
Step #1: Change your mindset
I enjoy making dough and bread from scratch. One day, while at the grocery store, I found a fantastic deal on 5-pound bags of flour. A bag of flour was on sale for only $1, which usually sold for $2. I was thrilled and bought the maximum limit of four bags. The following week, the sale continued, and I purchased another four bags of flour at $1 each. Before I knew it, I had 40lbs of flour that cost me only $8 (and yes, I used all of it!).
You need to think of the stock market like the bags of flour. Remember, when you invest in the stock market, you are buying small pieces of ownership in companies. It’s better to purchase shares when they are discounted rather than overpriced. Market downturns allow you to do just that. They enable you to buy into the market when it’s on sale, much like buying $2 bags of flour for $1.
It can be scary to see your investment portfolios decline when the market is in freefall, but that’s not the time to stop buying. In fact, it’s the best time to buy, which will set you up for bigger gains later on. We must adjust our mindset towards market turmoil and see market downturns as opportunities, like a doorbuster sale!
However, you must be prepared to take advantage of the sales prices when the time arrives. This leads us to the next step.
Step #2: Be Prepared to invest
During economic downturns, instead of reacting in fear like a zebra being chased by a lion, you must become the lion, waiting to pounce when the opportunity arises. To achieve this, you need available cash to invest. Moreover, you must be able to stay invested during market downturns. The last thing you want to do is be forced to stop or cash out investments to make ends meet.
Having a significant amount of debt and no savings puts you in a vulnerable position and limits your options. If you are overburdened by debt and have little savings, you will become desperate when the unexpected happens (and it will happen). This may force you to pause investment contributions. Worse yet, you may be forced to borrow, driving you further into debt and away from financial independence.
This limits your ability to invest at the most opportune time when fear is running high and markets are down. Instead of being able to ride out financial storms and potentially benefit from a down stock market, you can be forced to take drastic measures. So, now is the time to prepare for the next downturn.
While I won’t go into every detail, here are some high-level action items you can take to prepare.
Actions to take
There are no half efforts if you want to get out of debt and save. Only your total effort will do. You cannot rely on just one butt cheek – you need to use both.
Begin by listing all of your debts and their corresponding interest rates and minimum payments, along with your savings. If you have very little debt and a sizeable amount of savings, that’s fantastic! You are ready to face the unknown. However, if you are buried in debt, and your savings cannot cover a cheap cup of coffee, it’s time to take evasive action.
First, examine your spending habits over the past few months and see where you can cut costs. Next, build a small emergency fund between $1,000 to $2,000. This will give you a financial buffer as you get out of debt. Later, when you have more cushion in your budget, you can work toward building an emergency fund of 3 to 6 months of expenses.
As for paying off your debts, there are two main approaches: the debt avalanche and the debt snowball. The debt avalanche is based on math and has you paying off debt from highest to lowest interest rates. The debt snowball focuses on emotion and prioritizes paying off debt from smallest to largest amounts to give you a sense of victory and to keep you motivated.
There is no wrong answer on what method you use. You can do a hybrid if you want. Regardless of your choice, I suggest prioritizing consumer debts like credit cards and high-interest-rate loans.
Once you are prepared and your finances are in order, it is time to create an investment strategy that you can adhere to in the scariest of times. It all starts with risk, leading us to the next step.
Learn More
If you are starting off on your own and do not know where to start, I recommend reading the book “Broke Millennial: Stop Scraping By and Get Your Financial Life Together” by Erin Lowery.
Step #3: Know thyself and Risk
There are two important risk profiles you must know: risk tolerance and risk capacity. Knowing your risk tolerance and capacity will help you create an investment portfolio you will be comfortable with, regardless of market conditions. Let’s take a deeper look at each.
*Many companies you invest with, like your 401K provider, offer questionnaires to determine your risk tolerance and capacity. They can be a great resource and may even provide investment suggestions (make sure they are low-cost!).
Risk Tolerance
Risk tolerance refers to your emotional association with risk. It is your comfort level with accepting risk and falls on a sliding scale from being risk-averse to having a high-risk tolerance.
People with a high-risk tolerance allocate most of their investments to stocks and do not blink an eye when the market crashes. They view market volatility as a fun rollercoaster ride, giving them a chance to make more money.
On the other end of the extreme are people with low-risk tolerance who are risk averse. They lose sleep whenever the market goes down. People with low-risk tolerance prefer holding more of their investments in bonds and cash. If you are younger and fall into this camp, be careful. Cash and bonds carry their own risk: inflation risk.
Risk Capacity
Leave your emotions at the door. Risk capacity is all about numbers and math.
Risk capacity refers to your financial ability to take risks. It is the amount of risk you can take without putting your finances in jeopardy. The most significant influences on your risk capacity are age, income, and net worth.
In general, if you are young with a long investment horizon, you can take on more risk. As you get older and your investing time horizon shrinks, the less risk you can take. Let’s look at this in a little more detail.
When you are young and have decades to invest, you have a high-risk capacity. If you invest 100% in stocks and the market drops 50%, you can wait for the market to recover while continuing to invest. On the other hand, if you are retired with the same portfolio and the market crashes, it can be devastating. If you are in retirement, you are no longer earning a salary, and your investing time horizon is much shorter. Therefore, your capacity for risk is low.
Income and net worth also have a similar relationship to risk capacity. If you are earning a decent salary and have substantial savings with little to no debt, you will be able to take on greater risk, increasing your risk capacity. But, if you are struggling to make ends meet and are buried in debt with little to no savings, your ability to absorb investment losses is diminished, resulting in a low capacity for risk.
Step #4: Build a Diversified Investment Portfolio
Now that you know your risk profile, it is time to start allocating and building a diversified portfolio. A well-rounded, diversified portfolio helps to keep your feet on the ground during economic storms. It can help to maximize returns and minimize risk. There are two main ways to diversify your investments: across different assets and within each asset category. To get the most benefit from diversification, you need to do both.
Asset Allocation
Asset allocation means dividing your investments across different asset categories like stocks, bonds, and cash. It takes into account your risk tolerance and risk capacity. If you’re unsure how to allocate your investment portfolio, there’s a simple rule of thumb that can guide you, but it is not an exact science.
Begin by subtracting your age from 100, giving you the percentage of your investments that should be allocated to stocks. The remaining amount should be allocated to bonds, with a small portion held as cash. For instance, If you are 35, subtracting your age from 100 results in a portfolio of 65% stocks, with the remaining 35% going toward bonds and cash.
| Asset Type | Stocks | Bonds | Cash |
| Asset Allocation | 65% | 30% | 5% |
Some experts recommend adding real estate to your asset allocation. You can do this through a low-cost index fund or ETF specializing in REITs. REITs stand for Real Estate Investment Trusts and are companies that focus on owning, operating, and financing real estate. Here is an example of what it might look like.
| Asset Type | Stocks | Bonds | REITs | Cash |
| Asset Allocation | 65% | 20% | 10% | 5% |
These guidelines are not strict rules but rather provide direction. As such, there are variations on this rule, with some experts suggesting you subtract your age from 110 or 120 depending on your risk profile. Regardless of the method, you typically shift your investments from stocks to bonds as you age. You may also need to rebalance your portfolio each year to ensure your asset allocation stays on track.
* Always remember personal finance is personal. These rules of thumb can be a good starting point, but your asset allocation needs to work best for you. and your unique circumstances. When in doubt, consult a trusted professional.
Diversify
Most of us know the saying, “Don’t put all your eggs in one basket.” As we have seen above, diversification across multiple asset categories is the first step towards diversification, with each asset category serving as a different basket. The next step is to diversify within each of the asset types. The goal is to have multiple baskets within each basket.
The good news is that it is easy to diversify without the need to try and pick individual stocks and bonds. You can do it all by using low-cost index funds or ETFs.
For instance, investing in an S&P 500 index fund is a great way to diversify your stock holdings as it invests in the 500 largest publicly traded companies in the United States. If you want more diversification, you can buy a total stock market index fund. This type of fund holds stocks in thousands of US companies, from small to large. You can take diversification further by adding a total international stock market index fund to your portfolio, providing exposure to thousands of companies across the globe!
What is good for stocks is good for bonds. You can diversify your bond holdings by investing in a total bond market index fund and an international bond market index fund. This will allow you to hold bonds in many companies and countries, from established economies to emerging markets.
If you find choosing between investments overwhelming, you can opt for a target-date mutual fund that aligns with your retirement date and adjusts its investment mix from stocks to bonds as you near retirement.
Don’t worry if your 401K or employer-sponsored retirement account lacks low-cost index funds. No matter your plan, chances are it offers broad-based mutual funds or target date funds, although they may come with higher costs.
One final word on diversification
There is a third area of diversification you must consider. It has to do with the type of investment accounts you hold. Indeed, a 401K or similar plan can be a great way to save for retirement. However, you can expand your investment options and flexibility by opening investment accounts outside your employer-sponsored retirement accounts. By doing so, you no longer have all your investments in one account.
It is best to open additional investment accounts with a low-cost brokerage company, such as Fidelity and Vanguard. They offer investment options, including brokerage accounts and IRAs (Traditional or Roth). Both are solid selections, but I prefer Fidelity.
Fidelity does not charge any fees for opening or maintaining an account. Moreover, they offer a range of low-cost index funds and ETFs that do not require minimum investments. Fidelity has also introduced a line of mutual funds called Fidelity Zero Funds, which have zero expense ratios, no minimums, and no transaction fees. The absence of fees and investment minimums allows you to open an account with little money. Then, you can keep the account on standby or contribute to it based on the available funds in your budget.
Suppose the worst-case scenario happens, and you lose your job. In that case, you already have an established relationship with a low-cost brokerage company that can help you roll over your 401K into a lower-cost Roth IRA. And if your new job doesn’t offer a retirement plan, you can continue to invest without skipping a beat.
This leads us to the final step. It is simple but powerful and helps you stay the course when the world is turned upside down.
Step #5: Set it and forget it
Congratulations on reaching the final step! Now that you have settled on your asset allocation and investment choices, it is time to “Set It and Forget It.” After completing this step, you will be ready to take on the big, bad scary world. There are two distinct components to this final step: automating your investments and buying and holding.
Automate your investments
Automating your investments is simple yet powerful. In fact, David Bach wrote a best-selling book based on this principle titled “The Automatic Millionaire, Expanded and Updated: A Powerful One-Step Plan to Live and Finish Rich.” So, what does it mean to automate your investments?
If you contribute to a 401K or a similar plan, chances are you are already doing this. With every pay period, a portion of your income is automatically redirected to your 401K account, which is invested in a predetermined selection of funds. Once you set it up, the entire process operates on autopilot. You, as the pilot, make periodic adjustments to your contributions and investment allocations, and that’s it!
One of the best things about this approach is that it only takes a few clicks to automate your investment accounts. In addition to your 401K, you can easily set up automatic contributions from your checking account to your brokerage or IRA accounts. By doing so, you’ll be budgeting for investing just like any other expense, but instead of paying another company, you’ll be paying yourself. How awesome is that?
Automating your investments has another benefit, which is that it eliminates market timing. By setting up regular and reoccurring investments, you will continue to buy shares regardless of market conditions. This approach results in you purchasing more shares when the market is down and fewer when it’s up, which helps to lower risk over the long term.
Notice I wrote long-term, not short-term. Automating your investments is most effective if you adopt a long-term buy-and-hold strategy.
Buy and hold
Buying and holding is the secret to becoming a successful investor in a scary and uncertain world. To invest during market turmoil, you must be able to buy and hold during the worst times in the market. It will be difficult to fight your urge to sell during a bear market when your investment portfolio declines by 20% or more. Having the discipline to hold steady during the darkest days of the market separates the good investor from the bad.
No matter how diversified your investment portfolio is, you must come to terms with the fact that you will have down years. Some years are going to be downright awful. This is why a buy-and-hold strategy is so essential if you plan to invest for the long term. It is all about accepting risk in the short term for the potential for long-term gains.
To put it all in perspective, the Dow Jones Industrial Average was around 11,500 at the beginning of 2000. As of this writing, in 2023, it stands at over 34,000. Likewise, the S&P 500 index increased from around 1,400 in 2000 to over 4,000 by 2023. That is nearly a 200% increase for both indexes despite some of the most severe economic and global crises in modern history.
Think about it. In the past 23 years, we have witnessed the dot-com bubble, the worst economic downturn since the Great Depression, a global pandemic, and the worst inflation in 40 years. Despite these adversities, the stock market has bounced back and grown. Only long-term investors with a buy-and-hold strategy would have benefited the most from such a rise. If you sold your investments during market downturns and bought back in only after a recovery, you would have missed much of these gains.
Putting it all together
During economic and global crises, there will be a lot of noise. The news media are going to do their best to sell panic. Your acquaintances will scream that the sky is falling. If you buy into the narrative, you may succumb to fear, leading you to make bad investment decisions.
So, how do you invest in a scary world?
It’s important not to fear market downturns. Instead, view them as a chance to buy into the stock market at a discounted price. To become a successful investor, you must first get your finances in order. After that, create a diverse investment portfolio and stay committed even when the market fluctuates. The best way to achieve this is by automating your investing and adopting a buy-and-hold strategy.
Taking these steps will not prevent your portfolio from declining during market downturns. It also does not mean that you should never sell. Instead, these steps are intended to help you maximize gains over the long term while reducing risk.
Above all else, always remember that investing is not a short-term game. It’s a lifelong journey.
