You must stay invested in the securities markets to earn market return risk premiums Securities markets pay risk premiums to risk takers
You have to have your money invested and at risk to be paid a risk premium. Attempting to avoid risk or losses by jumping in and out to “time the markets” does not work. Scientific finance studies demonstrate the both amateurs and professionals are lousy at market timing.
Historically, U.S. securities markets have paid substantial risk-adjusted returns or risk premiums to investors. While risk premiums have been substantial, they have occurred irregularly. There have been intervening periods of losses, some of which were substantial. (See: How stable have common stock equity risk premiums been over time?)
To earn market risk premiums, your assets must be invested and exposed to potential risk or loss. The more risk you can tolerate, then the higher your potential return and perhaps the rougher the investment road you may travel. Those who have better emotional tolerance for asset volatility can more easily weather market sell-offs.
Practical considerations will also affect one’s tolerance of investment risk. In difficult times, whether you need to liquidate risky assets at depressed prices will depend on your expenses and on your other other holdings of less risky, salable assets. Paying necessary living expenses and taxes are good reasons to withdraw funds. Trying to time the markets for a better return is not a good reason.
If you do not need to take out money during a market retreat and recovery cycle, then risk tolerance is solely emotional. For a risk tolerant investor with stable earned income, the recent bubble crash was just a few years of unpleasantness, if he or she was fully diversified and, therefore, not heavily loaded with technology and communications equities. The same, however, could not be said for those who were poorly diversified and found themselves also to be highly risk averse, when risk actually happened. This is expecially true, if job loss forced the liquidation of assets at depressed values.
To some degree, all sane investors are averse to risk, so risk tolerance is a relative rather than absolute issue. Therefore, you need to judge your preference or tolerance for risk relative to other investors. While very few people like investment risk, those who can tolerate it better are those who will be less uncomfortable when risk happens from time to time and [...]