You're supposed to invest more money in the stock market when there's blood running in the street. Like many Wall Street adages, this is more easily said than done, especially when it's your blood that's running in the street.
What can you do to tough out the hard times, aside from sitting under your desk, sobbing? Experts say you should look on each new decline as a buying opportunity, which it is, assuming you have any money left. But your best friends in a long-term, choppy market are investing regularly, staying diversified, and rebalancing when things get truly out of hand.
When the Dow Jones industrial average is plunging 500 points because the head of a major bank is being sought in a bar stabbing, it's hard to go to a happy place in your mind where markets are rational. "That happy place for me is as far away as possible from the office," jokes Clearwater, Fla., financial planner Ray Ferrara.
His most effective happy thought, however, is that the day-to-day moves are transient. The Dow zigzagged 2,069 points from high to low between June 1 and Oct. 31. All told, however, the index was down only 2.7 percent. "If you were Rip Van Winkle and had gone to sleep during that period, you would have thought that not much was going on in the market," Ferrara says.
Wallace Weitz, manager of the Weitz funds, is paid to tough out the markets. And for investors in individual stocks, those big plunges can reveal some bargains. "It's easier to buy into the teeth of a big sell-off, when everything is going down together, if there's no reason to think the company you're looking at has problems," Weitz says. For example, owning shares of cable provider Comcast is a lot easier than owning shares of a major money center bank during a financial crisis, he says.
The normal advice for investors is to bear in mind your tolerance for risk as well as the overall investment mix of your portfolio. Your risk tolerance, however, may need reviewing if you had never imagined stock investing could be so hard on your blood pressure. If you're waking up every night shouting "I'm ruined!" it may be time to pare back your stock holdings.
Similarly, you may not need all the risk you're taking. The golden rule is, "Don't take any more risk than it takes to meet your objectives," Ferrara says. Suppose you have $500,000 saved for retirement. Your goal is $600,000. You have 10 more years before you retire, and you're contributing $10,000 a year to your savings. You don't need to be in the stock market to reach that goal: You'll get there on your contributions alone.
If you do need the potentially higher returns -- and higher risks -- of stocks, you can reduce your risks in several ways. The first: Add a set amount to your account at regular intervals. Most people do this anyway, via their 401(k). In a down market, you're buying more shares when the market is low, and fewer when it's high. Had you invested $100 a month into a typical large-company stock fund at the very peak of the stock market -- October 2007 -- you'd have $4,843 in your account now. Had you stuffed that money into a mattress, you'd have $4,800. In contrast, a lump sum would be worth $4,156.
In a rip-snorting bull market, a lump-sum investment always beats systematic investments. In a back-and-forth market like this, however, putting in a bit at a time will help performance -- and, possibly, that twitch in your left eye.
But the best cure for stock market volatility: Don't put all your money into stocks. Putting 40 percent of your portfolio into government bond funds the past 10 years not only increased your returns, but decreased your portfolio's moves up and down.
You can decrease volatility further by rebalancing from time to time -- moving money from your best fund to your losers. Your first step is to find a mix that suits you. Your second is to figure trigger points -- when you'll actually rebalance.
Some people rebalance annually, which is fine, particularly if you feel that stock market performance is closely correlated with the movements of Earth around the sun. It's generally better, however, to rebalance sparingly -- for example, when your portfolio is 10 percentage points off from its target. In the example in the chart, rebalancing was only necessary once in a decade.
Someday, we will have another bull market, and anything you do that doesn't involve putting all your money into stocks will make you look like the village idiot. But it's far better to look like an idiot when the bulls are running than when everyone is getting gored.
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