You raise one of the most important issues about long-term investing, and there is nothing ignorant about this question. All three alternatives you mention are viable, but may not be the best for you. Here are a couple of key things to consider:
Time horizon – How long do you have until you will need to use the funds? For example, someone who is 35 years old, would have a long time-horizon, assuming they plan to retire at age 65. Someone less than ten years away from retirement would have a shorter time-horizon. In general, the farther away the goal is, the more risk or volatility you can assume. The ability to take on more risk is often referred to as “Risk Capacity”.
Risk tolerance – This is different from risk capacity. Although someone may have 30 years until retirement, and be “capable” of taking on more risk in their portfolio, they may not be able to sleep well at night knowing they are taking on more risk. It is human nature for most folks to avoid unnecessary risk, so understanding that you may have the capacity to do take on more risk may help with the emotions.
Market timing – Not only do you have to time your exits from the market, but to guess when to get back in as well. An often used saying about market timing goes like this: “Investing for the long-run but listening to market news every day is like a person walking up a big hill with a yo-yo, and fixating on the yo-yo instead of the hill.”
The bottom line is to tune out all the “financial noise” that can derail your long-term planning. It’s hard to do, but remember the basics: understand the time-horizon for your goal(s), have an asset allocation that is appropriate for your risk capacity and risk tolerance, and manage the allocation over time as the time-horizon or your risk capacity/tolerance changes. Focus on the hill, not the yo-yo.
