This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

There's no way for investors to avoid recessions. Economic cycles are natural, and they can move the market drastically. That doesn't have to be a bad thing, though! Investors can use a few important strategies to limit losses and maximize long-term gains.

1. Stay invested

This is the most important strategy on the list, by far. It's also probably the most simple one. The stock market is likely to drop during or immediately following a recession. Our human instinct is to take action to stop the pain. It's not easy to do, but the best move is generally to fight this instinct.

The worst time to sell a stock is right after it's dropped. All that does is lock in your losses. The best time to sell has already passed, and chasing that is an irrational fear reaction -- it's already too late. You might prevent further losses, but you could also lock yourself out of the gains from the inevitable market recovery. Some recoveries take years following prolonged, steep crashes. Other ones are immediate, but either way, it's nearly impossible to know which one you're dealing with in the moment.

Suppose that nothing has changed about a company's expected future cash flows or financial health. For long-term investors, that means nothing has changed about the stock's potential. A drop in price just means that it got even cheaper, and, perhaps, less risky. From a purely rational perspective, a recession is one of the worst times to sell.

Even investors who recognize this logic can still be tempted to time the market. There's tons of data out there suggesting you probably can't do that successfully over the long-term. Instead, it's generally best to trust that the market will turn around as economic conditions inevitably return to growth.

2. Hold dividend stocks

Dividend stocks are great additions to investment portfolios, especially during market downturns. When investors' risk appetite declines, capital usually flows toward value stocks and other stable businesses. Dividend stocks become more popular when market turmoil is on the horizon. That's exactly what we saw in early 2022.

Dividend stocks also bring the major benefit of performing during market crashes. Your portfolio might get crushed and lose value on paper, but you can still enjoy cash returns, regardless of share prices. This is really important for retirees relying on investment income. It's also a great way to calmly stay invested as you wait for the stock market to turn around. You'll be less tempted to sell if some of your stocks are kicking off cash.

You can't avoid volatility, but you can definitely manage it. Investors can measure their risk tolerance based on time horizon, financial needs, and personal tastes. If you don't need to access your stock investments for a long time and you don't mind short-term losses, then you can invest for aggressive growth. If you'll need to sell your stocks for cash soon (or if you just can't handle losses emotionally), then it's important to balance your allocation in alignment with your risk tolerance. Bonds are a popular asset class for volatility reduction.

Recessions can threaten the profits and financial health of any business, which can cause them to slash dividends. Make sure your dividend investment strategy retains some exposure to defensive stocks, such as healthcare, consumer staples, and utilities. These are considered non-cyclical because their sales tend to remain more stable across economic conditions.

3. Manage volatility

This is an important investment strategy to consider before a recession hits. If you don't take care of this, it might be too late. Volatility is an inevitable part of stock investing. The market moves in cycles, and crashes tend to coincide with recessions.

If you missed the boat on this step in 2022, make sure you're prepared in the next market cycle. It will be relevant again in the future.

4. Stay liquid

If we're truly entering a recession, then it could be wise to keep some "dry powder" on the sideline. You'll be thankful if you have cash on hand when the market approaches its bottom. Don't mistake this for a recommendation to sell off your stocks and violate the first section of this list. With the market down 13% year to date, it's not exactly a good time to sell stocks anyway.

Instead, approach this as a form of volatility management. If you're overexposed to stocks, then it might be smart to take some gains on stocks that have outperformed recently. That cash can be deployed into better opportunities, such as stocks that have recently become undervalued. Energy stocks could fit this description after their recent inflation-fueled run-up.

5. Buy cheap, promising growth stocks

If you have some cash on hand after the market takes a beating, then it's time to consider undervalued growth stocks. Growth stocks take a beating during crashes, but they tend to outperform the market during bull periods.

Artificial intelligence, data analytics, cybersecurity, and fintech stocks are way below their 2021 highs. They might have more room to tumble, but the risk-reward balance has flipped. Valuations are much more rational, and these industries are among the most promising for the next few decades.

If you do some homework and have high conviction in a few of these names, it's a great time to consider adding them to your portfolio for the long term.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

The post 5 proven investment strategies you can use to ride out a recession appeared first on The Motley Fool Australia.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

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Ryan Downie has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Bear markets are pivotal times that can completely change long-term investing performance. Obviously, a market crash can erase years of diligent savings and shrewd investing in the course of a few months. On the other hand, pulling out of the stock market now can prevent you from getting big returns when it recovers. There are a few factors to consider before you can determine which route is safer.

The state of the stock market

By most people's definitions, we're in a bear market. The S&P 500 is down 20% year to date while the NASDAQ has fallen 30%. These sorts of declines are typically associated with stocks that have become very cheap, but that's not exactly the case right now.

Stock valuations were near all-time highs in 2021, so the recent downturn has simply dropped those valuations in line with historically normal levels. The average dividend yield for the S&P 500 still hasn't recovered to pre-pandemic levels.

SPY Dividend Yield data by YCharts.

Meanwhile, the forward PE ratio for the S&P 500 recently fell below 18. That's slightly below the pre-pandemic level -- which itself came at the end of one of the best decades in stock market history.

The rise of high-growth, low-dividend tech stocks within major stock indexes certainly plays a role in those metrics, but that doesn't explain everything going on. We can still conclude that stocks aren't particularly cheap across the board. They just aren't prohibitively expensive anymore.

Personal circumstances

That context is important. We can't make blanket statements about the market being cheap or expensive today. We can make educated guesses about the future of the market, but that's even more difficult to forecast when valuations aren't abnormally high or low.

This means that the safety of stock investing depends heavily on your own personal circumstances. Risk tolerance, investment time horizon, and financial goals all play important roles in determining the best course of action. Investors with short time horizons and low risk tolerance need to be much more careful about short-term risks. Investors with high risk tolerance and long-time horizons need to think very carefully about long-term opportunity costs if they refrain from investing.

It's probably a bad time for you to sell stocks

That said, it's a horrible time to sell for the vast majority of investors. It's easy to feel the sting from the most recent market crash, but pulling money out of the market at this time is just a reaction that's coming too late.

Humans are prone to a common mistake that can really complicate investment analysis. We tend to look at recent trends and assume that they'll continue. In reality, circumstances have changed drastically in capital markets. Some of the forces that were present at the start of the 2022 market crash are far less potent today.

The prospect of interest rate hikes by the Fed rippled through the market. Investors recognized opportunities for higher yields and grew fearful of an economic slowdown. After the Fed's aggressive hike in June, the market actually rose, indicating that these fairly extreme monetary policy changes were fully reflected by Wall Street. Expectations have come more in line with reality. Falling stock valuations also removed fuel for the sell-off. Huge quantities of growth investors who piled into tech stocks over the past two years have since closed those positions as the party ended. There's just not as much room to the downside.

That's a long way of saying that the market isn't bound to keep falling just because it's had a rough six months. If you pull money out of the market right now, you're simply locking in those losses. This isn't to say that the market won't fall further -- it definitely could. A recession looks imminent, consumers are still feeling the sting from high inflation, and global supply chains are still recovering from the COVID-19 disruption. It's hard to see a catalyst today that is going to drive valuations higher, and corporate earnings might be weak for the next few quarters.

When you should consider pulling money out of the market

The only people who should seriously consider selling are those who are too exposed to equities. People who are approaching retirement should have a balanced portfolio with both stocks and bonds. That's similarly true for investors who have relatively short-term cash needs or a personal aversion to risk. If your investment allocation is misaligned with your personal circumstances, then it might be wise to limit your volatility -- even if it means locking in some of your recent losses.

It's still not wise to completely abandon stocks in this extreme case. Stocks have a role in most portfolios well into retirement; they just need to be properly balanced.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

The post Is it safer to pull your money out of the stock market or keep investing for now? appeared first on The Motley Fool Australia.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

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The Motley Fool has a disclosure policy.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

What happened

Shares of fintech stock Block (NYSE: SQ) fell 26.6% last month due to the sell-off in growth stocks and cryptocurrencies. There wasn't any major negative news about Block's operations, but the stock suffered along with other correlated asset classes as investors pull capital out of risk assets.

So what

Block beat analyst estimates for the first quarter, and it reported those results in the first week of May. Investors are also looking forward to updates from the fintech disruptor later this month. Those events provide valuable insight on the financial prospects of Block's business. No such information was available in April. The biggest development was the company's announcement that it was launching a business lending product.

Instead, Block shares tumbled due entirely to market forces. Its price chart very closely resembled that of Bitcoin and the Proshares UltraPro QQQ ETF, which is a good proxy for growth stocks right now.

SQ, TQQQ, BTC Total Return Level data by YCharts

Investors are clearing out of volatile assets, including cryptocurrencies and high-valuation growth stocks. Block is a growth stock that is linked heavily with cryptos and blockchain technology, so it never really stood a chance in April's market.

Now what

Block is dealing with a slowdown, but it's still posting great growth results. The company's gross profit rose 34% last quarter. This marked a deceleration in the rate of expansion, but it broke a relatively flat trend from the prior three quarters. Gross profit inched forward in its Square business unit, while Cash App had a breakout month that propelled the whole company higher. Adjusted EBITDA rose over the prior quarter, but it's still down year over year. Block's recent acquisition of Afterpay also contributed to that growth, so its "organic" expansion was slightly worse than the headline figures would imply.

The value of transactions being processed by the company declined last quarter. That's likely to be a concern for investors. Consumers are hurting from inflation, and business activity could slow as interest rates rise from the Fed's aggressive monetary tightening. Be sure to monitor these trends over the next few quarters from Block.

Block derives a significant portion of its revenue from Bitcoin, and it has purchased more than $200 million in Bitcoin, which it holds on its balance sheet. As a result, the stock is likely to be highly correlated with the cryptocurrency markets for the foreseeable future. Bitcoin only contributed 3.4% of Block's gross profit in the last quarter, and its Bitcoin holdings amount to less than 1% of total assets on the balance sheet, so the market might be overreacting to crypto volatility in terms of its overall impact on the value of Block's business. This can create opportunities for long-term investors, but it will make the stock even more volatile in the short term.

Block remains a compelling opportunity to invest in a business that's committed to unlocking the value of Web3, the blockchain, and cryptocurrencies. 

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

The post Why did Block shares fall 27% in April? appeared first on The Motley Fool Australia.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

More reading

• Why this ASX dividend share is a retiree's dream
• The pros and cons of buying Qantas shares this month
• How many shares in this high-dividend toll road stock do you need for a $10,000 income stream?
• Which ASX 200 tech stock has Bell Potter just downgraded?
• Stop 'saving', start investing! How to target a $1 million ASX share portfolio

Ryan Downie has positions in Block, Inc. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has positions in and has recommended Block, Inc. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Investors don't need to panic when a market downturn hits. It's important to figure out the best strategy for navigating a rough patch. As always, there will be winners and losers in this volatile period.

You can transform your long-term performance by adopting winning strategies and avoiding losing ones right now. Here's how.

Winner 1: Investors with "dry powder"

It hurts to look at your portfolio value during a market downturn, but it's not time to bury your head in the sand. Corrections are huge opportunities for investors who have cash to deploy, known as "dry powder" in the financial industry. Stocks have become much cheaper relative to the underlying companies' sales, cash flows, and dividends. The downturn is like stocks have gone on sale, and it's the best time to buy.

Of course, it takes a combination of luck and foresight to develop that pile of cash. Most asset managers keep some portion of their portfolio in cash. The amount of cash tends to rise and fall with the manager's opinion on investment viability. Warren Buffett is holding an enormous amount of cash at Berkshire Hathaway because he determined stocks have been overvalued relative to their fundamentals.

Investors shouldn't have been out of the market completely going into this latest downturn. However, those who kept themselves from getting caught up in the fervor should have some cash on hand to take advantage of more attractive pricing.

Winner 2: Dividend stocks

Dividend stocks aren't immune from market downturns, but they tend to shine relative to other equities during tough times. Corrections and bear markets are signals that investor risk appetite has declined. Uncertain conditions cause capital to flow away from stocks and into other asset classes such as bonds and cash.

Those same forces are at work within the stock market as well. Growth stocks tend to take a beating, while dividend stocks hold up a bit better. Companies that pay dividends also tend to have more stable cash flows, and they often avoid catastrophic disruptions during economic turmoil. Importantly, dividend stocks still provide returns in the form of quarterly distributions, even if their share prices are temporarily down.

This is playing out as we speak. The Vanguard High Yield Dividend ETF is up about 2% year to date, while major stock indexes slumped. Growth stock valuations got a bit out of control, and investors are seeking safety as pricing falls back toward historically normal levels.

Data by YCharts.

Loser 1: Investors who sell

The only people who truly lose during a stock market downturn are investors who sell their stocks. Gains and losses are unrealized until they're locked in through a sale. Any position with positive returns can still swing to a loss until that position is closed -- the same is true for positions that are down.

In the history of the stock market, every single downturn has just been a temporary divergence from a long-term growth trend. If you sell during a downturn, you're buying high and selling low. You're losing your chance to capitalize on growth when the market recovers in the future.

But investors sell for all sorts of reasons. Some stocks are sold to cover distributions from retirement accounts. Sometimes, circumstances change in a financial plan, and assets have to be liquidated to meet cash needs. Or a portfolio has to be rebalanced to achieve a better mix of growth and volatility.

Too often, however, investors make fear-based decisions and exit the market due to the risk that losses grow even steeper. Selling in a downturn can help you avoid the impact of a full-blown bear market if it goes that far, but that's nothing compared to the opportunity cost of missing out on all future gains.

The best investors understand volatility is inevitable, and they don't throw out their whole investment plan when the market hits a rough patch.

Loser 2: Growth stocks

Growth stocks are usually great tools for long-term returns, but they come with extra volatility. They outperform when the market is up, and they underperform when the market falls.

Stock prices are theoretically based on expected future cash flows, and growth stocks have more uncertainty around those cash flows. It requires a bigger leap of faith to forecast the future earnings of a company that's rapidly expanding but doesn't produce any net profits today. The rewards are great if the story comes to fruition, but the risks are greater too.

Valuations peak at the top of market cycles, and growth stocks tend to have the most aggressive valuations when investor risk appetite is high. That leaves more room to fall when the market drops.

This doesn't mean investors should avoid growth stocks. Instead, it suggests they shouldn't be overexposed to this category, and they need to make sure they're ready to ride out volatility when it inevitably comes up.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

The post 2 winners and 2 losers during stock market downturns appeared first on The Motley Fool Australia.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

More reading

• Why this ASX dividend share is a retiree's dream
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• How many shares in this high-dividend toll road stock do you need for a $10,000 income stream?
• Which ASX 200 tech stock has Bell Potter just downgraded?
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Ryan Downie has no position in any of the stocks mentioned. The Motley Fool owns and recommends Berkshire Hathaway (B shares) and Vanguard High Dividend Yield ETF. The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway (B shares), short January 2023 $200 puts on Berkshire Hathaway (B shares), and short January 2023 $265 calls on Berkshire Hathaway (B shares). The Motley Fool Australia has recommended Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Big news is about to hit the stock market, and you don't want to be caught off guard when it happens. The Federal Open Market Committee (FOMC) is meeting this week to discuss monetary policy and interest rates, and there's a strong chance that stocks will react sharply to new information that comes out of that meeting. Make sure that your investment portfolio is set up to handle one of the biggest events in the financial calendar.

Why the FOMC is important

The stock market has been heavily influenced by interest rates over the past two years, and the Federal Reserve is the driving force behind interest rate changes.

Interest rates are often associated with relatively low-risk assets, such as Treasury notes and investment-grade corporate bonds. When interest rates are high, investors can generate decent rates of return without taking on much risk. However, periods with especially low interest rates force investors to look elsewhere for better returns.

That exact process has been happening over the past few months. Low rates tend to increase demand for stocks, especially high-growth stocks with more speculative valuations. That was important fuel for the COVID-19 bull market.

The Fed controls interest rates by buying and selling securities (usually Treasuries) on the open market. When the central bank purchases bonds, it increases demand for these securities and injects cash into the economy. This drives down interest rates and stimulates economic growth, so it's considered expansionary monetary policy.

Expansionary policy also tends to push inflation higher by stimulating demand for goods, services, and labor. The Fed sells securities and reduces the money supply if they want to raise rates.

The FOMC is the arm of the central bank that implements these strategies. The committee convenes every other month to discuss those actions, and the meetings are followed by a data release and a press conference. There's an FOMC meeting this week, giving investors rare insight into one of the largest economic forces as it changes.

If any of the information from this week's FOMC meeting differs from expectations, there's a good chance that the market shifts once again. The market's been shaky and the CBOE Volatility Index has been high, so any surprises from the Fed are likely to result in a big move up or down.

What to expect

There's no way to know exactly what the Fed will do, so any forecasts are speculation and guesswork. Still, we can make some educated guesses and prepare for a range of outcomes.

The Fed's core responsibility is balancing inflation and economic growth. Not everyone agrees with modern monetary policy, but there's plenty of evidence to suggest that central bank activities can reduce the severity of recessions or put a cap on irresponsible economic expansion. The idea is that a smoothly growing, more predictable economy is better for everyone in the long run.

The basic playbook is to cut interest rates when unemployment is high and to raise rates when inflation is too high. February's employment report smashed expectations, with nearly 300,000 more jobs added than anticipated. Unemployment dipped to a low of 3.8%, and there was also meaningful improvement among people who are underemployed due to economic reasons. We are closing in on pre-pandemic employment levels, which were very high.

Meanwhile, the latest inflation data indicates the largest consumer price increases in decades. Food and energy prices spiked due to supply shocks, adding to an already high inflation environment.

Since the FOMC last met in January, inflation has been higher than expected, while unemployment has been better than expected. That would indicate that the Fed will either maintain or accelerate its rate hike timeline.

Some people think that the Fed's hesitation to take any action has caused the stock market to dip. It's naive to think that the Fed doesn't consider stock investors at all, but the monetary authorities have previously taken actions that resulted in a stock sell-off. Inflation is a threat to economic stability right now if it's left unchecked, and the economy overall looks strong enough to absorb higher rates. Therefore, the monetary policy response seems pretty predictable.

Don't be surprised if the market reacts negatively as the Fed takes a more aggressive stance against inflation. Prepare yourself mentally and emotionally for volatility so that you don't panic if there's bad news. Make sure that your investment portfolio has the proper balance of growth and volatility so that you'll enjoy optimal results whether economic news is good or bad.

Remember: All of this is just a temporary disruption to long-term growth in the economy and stock market. You have to manage your way through this short-term stuff.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

The post How will the Fed's big announcement impact your investment portfolio? appeared first on The Motley Fool Australia.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

More reading

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• Stop 'saving', start investing! How to target a $1 million ASX share portfolio

Ryan Downie has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Most investors make an important mistake when they're building their investment portfolio, and it can be a costly one. Luckily, we can all take valuable insights from an important chart that's used by professional asset managers. This chart won't create the perfect portfolio for you, but it provides essential guidelines for building an investment allocation.

The efficient frontier

The efficient frontier is a chart that plots portfolio returns against portfolio risk. 

 

Source: RBC Wealth Management -- "Why does asset allocation matter?"

The chart is well-known among asset managers and financial advisors, but it's rarely mentioned by individual investors. Professionals have to focus more on risk management -- losses tend to shake a client's confidence in an asset manager. Meanwhile, financial media overwhelmingly covers market indexes and the performance of individual stocks.

Returns are intuitive. If you invest a certain amount of capital, the value of that investment grows or falls by a certain percentage. Over the long term, those returns are based on the fundamental performance of the asset. Companies that grow and produce profits tend to have stocks that appreciate. The stocks of unsuccessful companies generally lose value. That's all pretty straightforward. 

Risk is a bit more complicated, and there are whole fields of study dedicated to understanding it to a high degree. Risk is defined in different ways, but portfolio risk usually refers to volatility. Volatility is generally calculated as the standard deviation of returns over a given period, and beta is a popular metric for measuring relative volatility. Portfolio returns tend to follow long-term trend lines, but they fluctuate over the short term around that trend. The bigger the swings in a portfolio's value, the higher a risk it's considered to be. 

This chart suggests that there's a trade-off between investment risk and return over the long term. In an efficient capital market, investors are forced to accept more risk in exchange for higher expected returns. Equities are more volatile than bonds, but they produce larger gains in the long term. Growth stocks have higher upside than value stocks, but they're also prone to steeper losses due to high valuation ratios.

How the efficient frontier works

The efficient frontier is theoretical -- the exact numbers aren't really known or universally established. Instead, it represents the highest theoretical return that can be achieved at a given level of volatility. The curve is the collection of potential returns across the spectrum of risk, from low volatility to high.

From a portfolio composition perspective, any point along the frontier is just as valid as any other. It might seem odd to suggest that a strategy with a 6% average rate of return could be just as good as one with a 10% average return, but it's true in the context of asset management. Not everyone is in the position to assume the risk that's required to achieve higher rates of return, and the frontier illustrates a balance between the two. Investors with low risk tolerance can't achieve the same long-term growth as those with high risk tolerance.

Any point below the frontier is inferior to any point that's on the frontier. If a portfolio's long-term combination of volatility and returns places it below the frontier on a graph, then that portfolio is not compensating investors enough for the risk that's being taken. In that case, there are better allocations that could deliver more growth without adding any additional volatility.

Using the frontier

The key to portfolio management is to identify your optimal spot along the efficient frontier, then ensure that your investment strategy gets as close to the theoretical limit as possible. That's how the best allocations are defined, rather than simply the biggest gains over a small window.

The first step is to quantify risk tolerance, which should reflect time horizon and personality. Risk tolerance questionnaires are popular tools to accomplish this, and they allow investors to set a volatility target for a portfolio.

Once that volatility cap has been determined, it's important to maximize the potential growth within those boundaries. Obviously, that's easier said than done, and there are tons of variables and unknowns that dictate gains and losses moving forward. Fill your allocation with high-conviction stocks that will deliver growth, but make sure that it's governed by risk tolerance. That's the best way to place yourself on the right part of the efficient frontier curve.

People who have long time horizons and can stomach volatility are able to take more risks in favor of growth. Those portfolios should contain more growth stocks, small caps, and emerging markets. On the other end of the spectrum, some investors need to sacrifice growth to limit volatility. Those portfolios tend to have more bonds, dividend stocks, and stable value stocks. 

A 30-year-old should generally focus on growth in their 401(k) or IRA. Investors nearing retirement have to pull back on the reins to ensure that they aren't forced to sell stocks at the bottom of a market cycle.

We're seeing this in action with the current stock market correction. Any retiree whose well-being is seriously jeopardized by this pullback has mismanaged their volatility exposure and ignored the efficient frontier. 

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

The post Is this the most underrated chart for building your investment portfolio? appeared first on The Motley Fool Australia.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

More reading

• Why this ASX dividend share is a retiree's dream
• The pros and cons of buying Qantas shares this month
• How many shares in this high-dividend toll road stock do you need for a $10,000 income stream?
• Which ASX 200 tech stock has Bell Potter just downgraded?
• Stop 'saving', start investing! How to target a $1 million ASX share portfolio

The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

There's a right way and a wrong way to handle stock market crashes. Getting the next one wrong might permanently reduce your investment returns. Avoid these three common mistakes if you want to navigate the market cycle like a pro.

1. You shouldn't panic

It's nearly impossible to remove emotion from your financial plan. Who could be completely dispassionate when it comes to their kids' college funds or their retirement nest egg? You've spent years diligently saving and investing for growth, of course you're going to freak out a bit if your assets suddenly tank in value.

However, you have to resist the instinct to panic if you want the best long-term investment outcomes. That's easier said than done, but consider historical market dynamics for some valuable perspective. Volatility is a natural part of equity investing, and market crashes happen. If you're in the market for the long haul, bear markets are unavoidable. Don't blame yourself or your advisor when an event occurs that we should recognize as inevitable.

Recognize this fact ahead of time, and build your financial plan with this knowledge. When the market is down, remind yourself of this, and look forward to new opportunities that are around the corner.

2. You shouldn't sell your stocks

This one is a lot easier once you've mastered the "don't panic" approach. Selling your stocks in the midst of a market crash might be the worst thing you can do. It's the exact opposite of the buy-low,-sell-high cliché.

You can check the value of your portfolio any given day, but those gains are unrealized until the positions are closed. Open positions are like chips still on the table in a casino -- you're not really a winner until you cash out and leave the building. Obviously, it feels good when your accounts are up, but you have to sell your stocks in exchange for cash in order to purchase something else.

Selling your stocks at a market bottom locks in your losses. Even worse, if you get rid of your stocks and fail to buy back in, you'll miss out on some of the growth when the market inevitably recovers.

The key is understanding your time horizon and personal risk tolerance. If you're still 20 to 30 years away from retirement, your IRA or 401(k)'s exact balance today isn't exactly relevant. You'll go through a few more market cycles before you start making withdrawals. Since you have time to wait for another market recovery, you should prioritize long-term growth.

On the other hand, you shouldn't expose your investments to volatility if you need to liquidate them soon. Retirees, for example, might need to sell their stocks for cash in the next few years. They should build a more balanced asset portfolio to complement Social Security income. Adding bonds or cash will reduce volatility and limit losses. Don't put yourself in a position where you're forced to sell during a crash. Moreover, you'll have extra cash on hand to purchase stocks at lower valuations.

3. You shouldn't be scared of growth stocks

This takes the "don't sell" approach a step further. Market crashes are actually the best times to focus even more on growth, but some scary stock charts will probably cause some trepidation.

Growth stocks take a pounding during bear markets, so they'll probably have much uglier returns relative to value stocks and the market in general. History can be a valuable guide, but investment returns are built on future results. The stocks that drop the hardest in market crashes tend to be the ones that perform the best in subsequent bull markets.

This becomes clear when we look at the Vanguard Growth ETF's (NYSEMKT: VUG) performance relative to the Vanguard Value ETF (NYSEMKT: VTV) over the last two major collapse-recovery cycles.

Data by YCharts.

The merits of each stock play an important role in returns, but the trend applies, all other things being equal. This isn't to imply that you should be drastically changing your portfolio allocation. Overall, you should come up with a target allocation based on your personal goals and risk tolerance. However, shifts in valuation change the risk/reward profile of stocks over time. When the market crashes, growth stocks will look more favorable, and it's not a bad idea to modestly shift your portfolio to the most aggressive allocation that's acceptable within your personal risk profile. 

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

The post 3 things you shouldn't do if the stock market crashes appeared first on The Motley Fool Australia.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

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Ryan Downie has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. owns and recommends Vanguard Growth ETF and Vanguard Value ETF. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

If you want to invest without any risk, then the stock market isn't for you. Despite the market's inherent risks, it's still an important piece of the best financial plans. You just need to understand the most important threats involved with investing and set yourself up to safely avoid them. These four risks aren't the only ones that you'll encounter, but they are important considerations for building a sound investment plan.

1. Company risk

Company-specific risk is probably the most prevalent threat to investors who purchase individual stocks. You can lose money if you own shares in a company that fails to produce enough revenue or profits.

Poor operational performance can cause a company's value to drop in the market. In some cases, a company can report great sales and profit figures, but its growth or outlook isn't strong enough to meet overly optimistic investor expectations. In the most extreme circumstances, companies can completely collapse, resulting in the total loss of any capital invested. Enron investors can attest to this.

You can reduce company risk by doing your homework. Analyze quarterly earnings results, listen to management commentary on those results, and measure performance with different financial ratios. Read commentary from analysts, competitors, suppliers, customers, and other investors. Make sure that a stock's valuation makes sense based on its potential profits.

Unfortunately, all the homework in the world won't turn you into a psychic. You can't know what the future holds. Diversification is the only way to effectively eliminate company-specific risk. Consider buying other stocks in the industry -- or stocks across a number of industries -- just in case things don't go to plan. The more your own, the more you dilute the risk posed by any single stock. Mutual funds and ETFs are great tools for this purpose.

2. Volatility and market risk

No matter how well a company performs, its stock is still subject to volatility and market risk. Stock prices are determined by supply and demand, like anything else. If people are pulling capital out of the stock market in general, then stock prices are going to fall.

Market crashes are bound to strike on occasion, but history tells us that they're only temporary. The key here is to prepare yourself emotionally and position your portfolio to avoid the biggest drops. If you avoid selling when the market is down, then you'll never realize the losses. Holding on through a downturn keeps you in a position to reap returns when the market returns to growth. Make sure that you have a source of cash outside of your investment portfolio to cover unexpected expenses or opportunities.

You can also build a portfolio to limit volatility. Once again, diversifying the types of stocks you own can help. Defensive stocks and dividend payers tend to experience less volatility than growth stocks. Investors with short time horizons should also keep some of their assets in bonds, cash, CDs, or money market accounts. These aren't as volatile as stocks.

3. Opportunity cost

We can think about this as the risk of missing out. Opportunity cost refers to gains you could have attained by choosing a different investment. If I buy stock A, and it grows 10%, but stock B grew 15% in the same time frame, then my net opportunity cost was that 5% difference.

If you don't put yourself in a position to achieve responsible investment growth, then you risk leaving money on the table. As we covered above, you can't just go all-out for investment growth, especially if you're approaching retirement. Still, you'll want to minimize the risks associated with opportunity cost by allocating at least some of your portfolio to growth stocks. This is especially relevant for young investors saving for retirement with 401(k) or Roth IRA accounts. To determine how much of your portfolio should be allocated for growth, use a risk tolerance questionnaire.

4. Liquidity risk

Liquidity risk doesn't get a lot of attention, but it's important and intuitive. Liquidity refers to the ease with which an asset can be exchanged for another (usually how fast it can be sold for cash). Cash is the most liquid asset. Stocks and bonds are also usually considered highly liquid. Real estate and private business ownership are on the other end of the spectrum. It can take months or years to sell those assets. Illiquid assets are difficult to unload to realize gains or cover unexpected cash needs.

While most stocks and ETFs are highly liquid, they aren't all equal. Thinly traded equities, such as penny stocks, unpopular ETFs, or certain small-cap stocks can present some issues. You might incur higher costs to trade these securities, with high bid-ask spreads, for example. You should also consider functional liquidity across different account types. Assets held in qualified retirement accounts, such as a 401(k), might only be available to you after paying an early withdrawal penalty.

To manage liquidity risk, research daily trading volumes and the bid-ask spread for any stocks you want to buy. If you are going to hold illiquid investments, make sure you have enough liquidity elsewhere in your plan to meet your potential needs.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

The post 4 real risks of investing (and what to do about them) appeared first on The Motley Fool Australia.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

More reading

• Why this ASX dividend share is a retiree's dream
• The pros and cons of buying Qantas shares this month
• How many shares in this high-dividend toll road stock do you need for a $10,000 income stream?
• Which ASX 200 tech stock has Bell Potter just downgraded?
• Stop 'saving', start investing! How to target a $1 million ASX share portfolio

The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

You need to time it more than once

A small number of days generate a large proportion of returns

Entry points are less important over the long term

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

The post Trying to time the stock market is a bad idea — here's why appeared first on The Motley Fool Australia.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

More reading

• Why this ASX dividend share is a retiree's dream
• The pros and cons of buying Qantas shares this month
• How many shares in this high-dividend toll road stock do you need for a $10,000 income stream?
• Which ASX 200 tech stock has Bell Potter just downgraded?
• Stop 'saving', start investing! How to target a $1 million ASX share portfolio

Ryan Downie has no position in any of the stocks mentioned. Bank of America is an advertising partner of The Ascent, a Motley Fool company. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Tesla Inc (NASDAQ: TSLA) returned more than 720% for investors in 2020. That's a huge year by any standard, and holders should be very excited by that performance. However, for many, it creates an allocation problem that requires rebalancing.

As I see it, the worst mistake that Tesla investors can make is to ignore the need to diversify. This suggestion may fall on deaf ears for speculators or Tesla disciples, but it's a great time to sell a portion of your shares while retaining some for future growth.

The auto-maker grew aggressively in 2020

Tesla was one of the most popular stocks among investors coming into 2020, and many people held it as part of their portfolios. That stock has almost certainly grown to take up a much larger portion of their portfolios since the start of last year. A hypothetical portfolio that was 5% Tesla at the start of 2020, with the remainder spread between the S&P 500 Index (SP: .INX) and the Nasdaq Composite (NASDAQ: .IXIC), would now be roughly 25% Tesla due to that one position's excellent performance.

There's some dissent among Fool contributors and the investment community on this topic, but I'm a staunch advocate of diversification and rebalancing. This is especially important if stock performance is being driven by valuation inflation rather than fundamental growth. In the above example, investors established a volatile, high-growth position with 5% of the portfolio. Having exploded in value, Tesla now has less upside potential and more downside risk. To replicate this year's performance, the company would have to grow to $5.6 trillion in value. Tesla is likely to continue performing well, and that huge valuation may indeed be attained eventually. However, it's going to take a while, and I expect that we'll go through some market corrections before that day comes.

Tesla holders should be excited-the stock delivered your gains ahead of schedule without a corresponding rise in sales, and there's a good chance you'll be able to purchase more again later at a less aggressive valuation.

Rebalancing, taking gains, and allocation

Even if you fundamentally agree that rebalancing is important, the actual moves required to rebalance may be difficult to accept. Tesla is looking at 30% sales growth in 2020, and it achieved quarterly profits for the first time last year. Analysts are forecasting rapid growth again in 2021.

It might seem strange to sell a stock that's delivered great returns while reporting strong fundamentals and looking at another great year. However, that's exactly what you have to do to effectively rebalance.

The bull narrative for Tesla has not been disrupted. In fact, the auto maker's sustained growth and recent profits validate the optimism about the stock. Why would you need to sell some, if that's the case? Because risk is still present here.

Tesla trades at a forward price-to-earnings (P/E) ratio of 175, a price-to-sales of 24.5, and a price-to-book ratio of 41.7. Investors should expect promising growth stocks to attract high valuation ratios like these, but Tesla holders need to recognize that significant amounts of future success are already assumed in this price. Continued strong results are necessary to justify the current price. Any indication that Tesla might fall short of the market's optimistic forecasts could send shares tumbling, even if the company keeps growing.

That might not be an issue for bullish long-term holders who just want exposure to the eventual market leader they expect Tesla to become, but others recognize the opportunity to redeploy that capital into other stocks that can deliver strong returns without as much risk concentration. Growth investors can sell some Tesla shares and use the proceeds to buy several other high-growth stocks. Recent big-name IPOs and hot stocks from industries such as e-commerce, cybersecurity, or telehealth can offer tremendous upside along with the opportunity to dilute the risk that any single stock performs poorly.

Don't overreact

Rebalancing shouldn't mean completely abandoning a good position, either. It makes sense to lock in some gains and retain a smaller position in Tesla to take advantage of potential future growth. Investors might be nervous about Tesla's aggressive valuation, but that company may well become a leader in multiple major industries for the next several decades. Most investors who allocated a certain proportion of their portfolios to Tesla last year should feel comfortable allocating a similar percentage of their holdings to the stock this year. 

Tesla may have attracted large numbers of speculative growth investors, and they might not like to hear it, but this is a great moment to take some gains and reinvest them elsewhere. The stock has outperformed the rest of the market so drastically over the past 12 months that it has left portfolios over-exposed to its performance. This is especially risky with Tesla's high valuation ratios. Bullish investors should keep some of this stock in their portfolios to benefit from future growth, but there are more than enough high-potential companies out there to warrant diversification.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

The post The worst mistake Tesla investors can make right now appeared first on The Motley Fool Australia.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

More reading

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Ryan Downie has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends Tesla. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.