How to invest during times of uncertainty is a quandary. Rewards are enticing but risks feel monumental. How should you invest to get the most reward for the least risk?
Navigating a volatile market can be challenging, but with a strategic approach, you can position yourself for success. Asset allocation strategies vary by investor, but most agree that a volatile market is not the best time to gamble. Instead, individual investors should rely on classic investment principles that have proven effective over decades.
The Risk/Reward Equation
Investing 101: the higher the reward, the higher the risk. A wise investor aims to maximize reward while minimizing risk. Since all market predictions are speculative, making short-term bets or trying to predict what will rise or fall is not a strategy. An allocation that considers all possible outcomes works best. Index funds, for example, allow you to invest in the overall market without having to pick individual stocks and bonds which can greatly reduce non-systemic risk.
The power of investing lies in compound interest. However, to fully reap its benefits, time is required. Your time horizon, or the amount of time an investment will be held until liquidation, is very important when considering the best asset allocation for you. Those with short horizons--older retirees or parents putting aside money that will eventually be used to fund a child's education--are especially vulnerable to serious losses. Therefore, money market or fixed-income securities are suitable.
It is essential to remain patient and resist the urge to react impulsively to short-term market movements. For better diversification, you can also combine an index fund, for example, with short-term treasuries (money-market funds or short duration bond funds) to generate better returns without risking significant losses. Those with larger time horizons should opt for stocks, mutual funds or index funds since they have time to persevere through market highs and lows. Your feelings of uncertainty needn't determine your investment approach.
Diversification
One of the most effective strategies involves diversifying your portfolio across various asset classes. This will mitigate risks as different investments react differently to market fluctuations. With successful diversification, you can guard against substantial losses by mixing high/low risk and positive/negative beta assets. Your goal is to determine an asset allocation that combines asset classes in a way that reduces your risk and maximizes your expected return.