The path to building a portfolio of savings and investments that can help you reach your long-term goals like retirement requires taking on some risk. The stock market has plenty of red days, and not every investment pans out.
But risk is a normal part of investing, and people who fear losing money may be holding themselves back from reaching their financial goals.
What to know about opportunity cost
If you’re tempted to keep your money in cash on the sidelines, consider the impact of opportunity cost, or the potential gains you miss out on when choosing one investment over another. In other words, how much are you losing by playing it safe? For instance, if someone invests $10,000 in an S&P 500 index fund that maintains an annualized 8% growth rate over 20 years, that $10,000 will turn into close to $47,000.
Meanwhile, $10,000 in a checking account — which typically doesn’t earns interest — won’t grow at all (and inflation will eat away at your purchasing power). High-yield savings accounts have higher annual percentage yields (APYs), but those yields are still typically much lower than what you can get from the stock market.
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Using the bucket strategy
Many investors fear losing money in a market crash, and investors who witnessed 2008, 2020 and 2022 have reasons to be concerned. However, downturns are a natural part of investing in the stock market, and those same drops can present compelling buying opportunities.
While young investors tend to buy dips, older investors who are approaching retirement may prefer to take a more conservative approach. That’s why the bucket strategy — which involves allocating money to short-term, mid-term and long-term assets based on your time horizons — can help. The strategy involves having some cash on hand for emergencies and short-term goals. Retirees may want to hold enough to cover one to two years of their living expenses. That way, you don’t have to sell stocks to cover basic living expenses and can ride out market volatility.
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Review your risk tolerance and financial goals
Everyone should know their risk tolerance and financial goals before deciding how much to invest. Your risk tolerance reflects how much money you are comfortable putting on the line for long-term growth.
Your financial goals may include buying a home or retirement, or short-term goals like going on vacation or throwing a wedding.
It’s important to align your financial goals with your risk tolerance — but it’s also important to be realistic. You’re not likely to turn a $1,000 portfolio into a $1 million portfolio in three years unless you make high-risk speculative investments, which is a risk most investors don’t want to (and shouldn’t) take on.
Choose investments that best align with your risk tolerance, but also don’t choose fear over future growth. Striking the right balance makes it easier to build sustainable wealth and makes your portfolio less susceptible to dramatic price swings.
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