Avoid Common Mistakes in a Down Market
Unfortunately, investment markets don’t always go up. As a matter of
fact, the U.S. stock market has declined about one-third of the time
since 1926. Seeing the value of your investments go down can often be emotional,
but the markets have produced consistent increases in value over
very long periods and through all kinds of challenges. Here are some things
to focus on when the inevitable down periods occur.
Keep Cool
Don’t let a market slump make you do something you’ll regret later or derail
your investment program. When the going gets tough, the urge to bail out
of stocks can be strong. But panicking can wreck an investment plan faster
than anything. Being out of the market won’t allow you to keep up with rising
costs of living. In addition, repurchasing later may result in a cycle of buying
high and selling low. If you haven’t developed a long-term investment plan,
do it now. If you have, review it to make sure it still reflects your financial
goals (see Strategy #13).
Here are some things to consider when markets are rocky:
- Communicate with your financial advisor, if you have one. Financial
advisors earn their keep in turbulent times, and a good one will be able
to walk you through the holdings in your portfolio and reaffirm your
investment strategy.
- Do nothing. Sometimes doing nothing is preferable to action. Try leaving
your account statements unopened for a while. When you look at
them every three months or so, you may find the account values are
higher than you thought, especially if you’re adding to them on a regular
basis.
- Don’t watch, listen to, or read too much commentary. During a downturn,
the news media has plenty of disheartening stories. The talking
heads and bloggers are there for infotainment, not to make you money.
- Act less like a day trader and more like legendary investors Warren
Buffet and John Bogle. They see market madness as normal and transitory
and take advantage of opportunities in the hard times. Check your stomach
for risk. If a big dip invokes too much anxiety, consider putting a larger proportion
of your portfolio in less risky assets, like bonds and even cash. But
be sure that doing so doesn’t jeopardize your long-term goals.
Stick to the Basics
Market turmoil causes investors to question their own judgment and seek
different approaches, but the only thing investors really need to do is follow
some fundamental principles. Consider the following:
- Invest in securities and use strategies you can easily understand and
that have withstood the test of time. The subprime mortgage crisis and
the collapse of Enron are examples of strategies that failed because some
very smart people couldn’t control their complex schemes. Be sure you
understand your investments, including risks, fees, and other costs.
- Make sure you’re well-diversified globally. The U.S. isn’t the only
market in the world, and every day we become more dependent on a
global economy. See Strategies #39 through #46 for strategies and asset
allocations that will make your portfolio less risky.
- Use mutual funds and exchange-traded funds. Unless you have at least
$500,000 to invest and the time and expertise to monitor individual
securities closely, you’ll be better off with well-chosen mutual funds or
exchange-traded funds (ETFs). (See Strategies #20 and #22 for the ins
and outs of these investment vehicles.) The value of an individual stock
or bond can go to zero, but a mutual fund is usually so diversified that
losses are temporary. To reduce risk, limit any single stock or bond to
no more than 10 percent of the portfolio. Be conscious of too much overlap
in individual securities or in styles of funds in your portfolio. Your
advisor or online tools can help you analyze the portfolio.
The 10-percent rule especially applies to employer stock. High concentration
in employer stock is one of the most common mistakes made by
401(k) participants. Be aware of how much company stock you hold in
all your various portfolios. With your employment and potential retirement
benefits already aligned with the fortunes of your company, limiting
personal exposure in your company’s stock is best.
- Keep costs in mind. High costs are magnified when returns are low. Selfdirected
investors can minimize costs by using index funds and ETFs. If
you need or want an advisor, don’t be afraid to ask how the advisor is
compensated and about the expenses of the products used.
Uncertain economies and markets make adjusting your portfolio even more
important. Many proprietary products handcuff investors by imposing heavy
surrender charges or exit fees. Annuities are the most common offenders, but
other illiquid investments, such as limited partnerships, can keep you from
making the necessary changes.
