8 Keys to Handling Market Turbulence
- Monday, September 26, 2011
As we've seen lately, stock prices are capable of sharp, erratic behavior. Since the financial panic of 2008, stocks have traded more as a group than as ownership interests of individual companies. The increasing sway of government and Federal Reserve policies on the markets has been a primary cause, though other factors have also played a role: high-frequency computerized trading, the trend towards indexing strategies, and the globalization of markets. It's disconcerting to the average investor, but it's not going away. So how can we remain calm when the financial world appears to be suffering a bout of temporary insanity? Here are some suggestions.
• Remember that market down turns, while unpleasant, are a normal part of investing in stocks. Since 1962, the stock market has averaged one correction of 10% or more roughly every other year. (Of the 25 corrections since 1962, only nine went on to become full-fledged bear markets, with losses exceeding 20%.) It's easy to forget how scary these declines are, but take comfort from the fact they are a normal part of the stock market's typical "two steps forward, one step back" progress.
•Understand that even severe bear markets aren't insurmountable obstacles for long-term investors. The two recent bear markets were quite severe by historical standards, so it's no surprise that investors are fearful that a third could be looming. But it's helpful to recognize that for long-term investors following SMI's Upgrading strategy, even these severe bear markets represented only temporary setbacks.
An Upgrader who stayed the course through the 2000-2002 bear market would have erased all losses by August 2003. The deeper 2007-2009 bear market took longer, but even then, Upgraders had broken even by April 2011.
• Imitate the styles of the successful — avoid a trading mentality. Many studies have confirmed that an active buying and selling strategy is counterproductive for most investors. One study of 10,000 accounts at a major discount brokerage house over a seven-year period found the stocks that investors sold performed better than the ones they bought. Don't assume you will improve your results by buying and selling in response to market volatility — these studies have confirmed it's a very tough thing to do.
• Accept the reality of today's financial environment — expect market turbulence. Volatility has become a permanent feature of our globally-linked markets. You must plan with this in mind. That means at least two things. First, diversify to lessen the impact on your portfolio when setbacks take place. Yes, great profits can potentially be made by concentrating your money in one or two investments, but huge losses are also possible. By avoiding this temptation, you know that no loss will devastate you. Second, develop a long-term view that resolutely looks many years out, ignoring the news of the moment.
• Think of your monthly cash flow needs and keep sufficient liquidity. Your standard of living over the next few years, which involves such things as making your monthly debt payments and meeting your routine living expenses, shouldn't be dependent on how well the market does. Keep sufficient reserves in money market accounts and short-term bond funds so you can afford to leave your stock market commitments untouched for up to five years if need be. With a faraway horizon, current fluctuations need not concern you — you've got plenty of time for any selloffs to run their course.
• Focus on where you want to be financially in five to 10 years. Don't become preoccupied with avoiding short-term losses. The important thing is that your portfolio mix is appropriate in light of your long-term personal goals. Any steps to significantly reduce the volatility in your portfolio will involve lowering your commitment to stocks which, in turn, is likely to reduce your long-term returns. So, make changes only after much consideration of the long-term consequences, and make them gradually.
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