By: Investor Solutions, Inc.
Does the financial news have you gripping for the “Tums” lately? It’s almost impossible to dodge the recent chatter, as current stock market volatility has the talking heads spinning. The global credit crunch and slumping real estate market have had a far reaching impact on the global markets in the short run. Clearly, none of us enjoy seeing indexes plummet (except for investors trying to short the market). But, when stocks slide south, “panic and sell” is not the right strategy. In fact, it’s completely irrational.
Look, nobody said investing in stocks was a walk in the park. If you want a “worry free” T-bill experience, then you deserve to get T-bill returns. As investors, we get compensated for taking risks. That is why they call it a “risk premium”.
Short term market gyrations are just part of the deal and markets usually snap back in a matter of time. If you cash out when the markets dip and sit on the sidelines for the “right time” to get back in, you will likely miss out on critical potential growth. The fact is, large market gains can come in quick and unpredictable spurts. Missing just a few days of strong market returns will substantially erode your long term performance as depicted in the chart that follows.
(Source: Dimensional Fund Advisors)
There is no possible way that you can foretell these market events, which is why we are strong believers in a passive investment strategy. Daily market returns are completely random. The worst market day in our recent history was October 19th, 1987 (Black Monday). If you were an investor back then who panicked and retreated to cash, you would have missed the best single day following that event on October 21st, just two days later.
The most important defense you have right now, and always, is a sound portfolio design and patience. Emotions have no room in investing. If you have a properly structured portfolio, market corrections and economic disruptions become irrelevant. However, if the market volatility is keeping you up at night, then my friend, you are in the wrong portfolio. Market uncertainty is the best scenario to gauge your true risk tolerance. If Tylenol PM became your best friend during the last few weeks because the volatility kept you awake at night, I might suggest you re-asses your portfolio and scale back on the risk.
So, let’s keep things in perspective. The US economy is not falling apart and it should weather the issues going on in the credit markets. Remember that risk is natural part of investing and market corrections are all part of normal market cycles. Without either, we would not be adequately compensated for our investments. For several consecutive years now, we have all enjoyed the upside of that same risk.
In summary, short term performance can really test your commitment to your investment plan. But, it’s in times like this that investors have to keep an even keel. Investing in equities will reward investors who keep a long term outlook, and bailing out when the going gets tough is simply the worst thing you could do to yourself.
Investing in equities involves a serious principal risk, and no assurance can be given that the techniques described here will be successful. Returns vary and you may have a gain or loss when you sell your shares. Past performance is no guarantee of future results. Index returns shown are historical and include the change in share price, reinvestment of dividends, and capital gains. Indexes are unmanaged and do not reflect the impact of transaction costs. Transaction costs would have reduced the total returns.
International investments, especially those in emerging markets, entail greater risks (as well as greater potential rewards) than U.S. investing. These risks include political and economic uncertainties of foreign countries, as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less-established markets and economies.