Here's how to white-knuckle your way through the ups and downs.
Bad news about the stock market can sound downright violent. Stock prices not only drop — they fall, dive, plunge, plummet and crash.
That can be a little scary when thinking about your money.
But don’t let fear of volatility keep you from investing in the stock market for long-term goals like retirement. You’ll need the returns of the stock market over the long haul to build a healthy nest egg.
“If you’re not in the stock market, you don’t have the potential positive gains you really need to grow your portfolio,” says Kelly Ennis, a certified financial planner and president of Infinity Financial Strategies in Granby, Connecticut.
Here's how to weather stock market bumpiness by investing over many years and diversifying your investments.
Expect some ups and downs
An annual return is the amount an investment grows in a year. The stock market’s average annual return is about 10% as measured by the S&P 500 over almost the last century. The S&P 500 includes the 500 largest, publicly traded U.S. companies and serves as a benchmark for tracking stock market performance.
But you can’t expect a 10% return every year. Some years deliver even better performance, while other years deliver losses.
» MORE: What is a stock?
The first thing I tell investors is volatility is normal.Melissa Sotudeh, certified financial planner with Halpern Financial
If you charted the course of a stock index like the S&P 500 on a graph, the line would be squiggly, notes Melissa Sotudeh, a certified financial planner with Halpern Financial in Rockville, Maryland. But the overall trajectory over many years would be upward.
“The first thing I tell investors is volatility is normal,” she says.
Says Ennis: “We shouldn't expect the path ... to be a straight line. There will be peaks, valleys and plateaus on the way."
Give yourself time
Because the market goes up and down, you generally will need to hold investments there for many years to get close to that average 10% annual return. If you’re young and saving for retirement, you’ve got plenty of time to smooth out the bumps.
If you’re savvy enough to have maxed out retirement contributions, saved for emergencies and paid off high-interest debt like credit cards, you might think about throwing some extra cash in the stock market.
But don’t invest any money you’ll need soon, such as the savings for a down payment on a house you plan to buy in a few years, says Robert “Robby” Schultz III, a certified financial planner and partner at Rollins Financial Inc. in Atlanta. The market could go down just before you need the money.
“You won’t have the time horizon to make up for a loss,” he says.
Spread out the risk
Diversification means having a variety of investments, rather than sinking all your money in one asset. Having a diversified portfolio reduces risk and still lets you reap solid returns over time.
You don’t have to be a financial wizard to diversify. You can do it by investing in mutual funds and exchange-traded funds, which pool investors’ money into an array of stocks, bonds and other assets.
If you are diversified, so you don’t have all your eggs in one basket, that volatility shouldn’t be as scary.Melissa Sotudeh, certified financial planner with Halpern Financial
A human financial advisor or robo-advisor can help you choose diversified investments according to your goals and timeline. Or you can select a target-date fund, which is a mutual fund that automatically adjusts its holdings as you get closer to retirement. Your investments should also be geared to your risk tolerance—how much of a drop you can stomach as you hold on for the ride.
“If you are diversified, so you don’t have all your eggs in one basket, that volatility shouldn’t be as scary,” Sotudeh says. “You’ve prepared for it and planned for it.”
Don’t let nervousness from a temporary drop in your portfolio value keep you from contributing to your 401(k) or IRA, Schultz says.
There’s a bright spot in market dips if you’re a long-term investor and regularly buying, as you are when contributing to a retirement account with every paycheck. Your contributions buy more when prices are down.
“You’re actually going to get a bargain once in a while,” Sotudeh says.
Says Ennis: “When the market drops, I remind my clients that we don't want to buy high and sell low. We participated in the decline and now we want to participate in the recovery.”