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Investing
How to Take Market Turbulence in Stride
CBNMoney.com
– As we've seen lately, stock prices are capable of sharp, erratic behavior. Stocks sometimes trade more like commodities than ownership interests in individual companies. There are reasons for this having to do with futures trading, hedging, indexing, 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 around us appears to be suffering a bout of temporary insanity? Here are some suggestions.
LOOK BACK
• Remember that market down turns, while unpleasant, are a normal part of investing in stocks. On average, the stock market has experienced a correction of 10% or more roughly once per year. The lack of volatility since 2003 has been the exception, not the rule. In fact, this has been the second longest stretch without a 10% correction on record. 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.
• Consider the historical record—be realistic in your expectations. The long-term average return for blue chip stocks over the past 75 years is roughly 10% per year. So after shooting up more than 70% in the past three years, having the market pull back a bit isn't a big surprise. It has been jarring to newer readers to see Upgrading lose more than the market indices, but remember that Upgrading had gained more than 125% from the March 2003 lows. In that context, the drop of 16% or so from early-May to mid-June doesn't seem quite so frightening. Setting reasonable long-term profit expectations for your investments will help you be more accepting of inevitable periods of market weakness.
LOOK AROUND
• 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. Don't be fooled by the calm of recent years—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. 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. And second, develop a long-term view that resolutely looks many years out, ignoring the news of the moment.
LOOK AHEAD
• 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 funds and short-term bond funds so you can afford to leave your stock market commitments untouched for up to five years if need be. Then, with a distant horizon in view, 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 ten years. Don't become preoccupied with avoiding short-term losses. The important thing is that your portfolio is comprised of securities that are 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 in your investment mix only after much consideration of the long-term consequences, and make them gradually.
LOOK UP
• Exhibit fruits of the Spirit—practice patience and self-control. Take your cue from the Parable of the Talents where the master was away for "a long time" and make sure your strategy is a long-term one. This allows you to take up-and-down market cycles in stride. If you invest regularly, continue doing so regardless of market conditions. Your long-term dollar-cost-averaging will use temporary setbacks to your advantage.
• Remember your heavenly Father—trust His promises. "Look at the birds of the air; they do not sow or reap or stow away in barns, and yet your heavenly Father feeds them. Are you not much more valuable than they?. . . But seek first his kingdom and his righteousness, and all these things will be given to you as well" (Matthew 6:26, 33).
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