Why should I invest in the market when I can buy and sell houses or cars?

By Ken Clark AAA
A:

This is a classic investor dilemma. When the markets are roaring, with 15-20% returns, it is tough to imagine putting your money elsewhere. In fact, when the markets churn out 15-20% returns, people actually tend to borrow money to invest in stocks.

Of course, when the markets are down by the same amount, especially over the course of a few years consecutively, it seems pretty easy to find more productive, useful, and fun places to invest that money. Even if you're not making huge profits buying and selling houses or cars, you at least feel like you're doing something productive. However, before you trade in your 401(k) for a Ferrari or a beach condo, try to employ the following three principles.

First, every long-term investor should focus on diversification as a core principle. If your portfolio has become top-heavy with just a few positions, you'll want to consider rebalancing toward not just other stocks or mutual funds, but also toward fixed income investments such as bonds and real estate.

Second, if at all possible, you should continue to invest funds regularly into retirement and college accounts. This process of dollar-cost averaging helps to ensure that your purchases that have temporarily declined in value are offset with new purchases at much lower prices.

Third, timing the market is nearly impossible. Over the last 80 years, equity markets have continued to provide an annualized return in the ballpark of 10%. Much of this return, however, is due to relatively short bursts of growth that happened before most cautious investors regained confidence to reenter the market. To have a fighting chance at earning double-digit returns in the stock market, you'll need to have your money invested properly before the market turns around.

(For more on this subject, read The Stock Market: A Look Back, Dollar-Cost Averaging Pays, Dollar-Cost Averaging DCA, Diversification, The Importance of Diversification, Market Timing Fails As A Money Maker)

This question was answered by Ken Clark.

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