Recession fears, rising unemployment, and stock markets plunging worldwide: What’s a poor investor to do? Not only are the headlines scary and unsettling but so are the monthly statements from your broker showing a drop in your portfolio value. It can be very hard to maintain your focus and long-term commitment to the stock market when investors all about you are losing their heads. Seasoned investors know that times like these demand calm and patience, rather than panic and action. In fact, it is usually better to sit it out and do nothing until the dust settles.
Here is a guide to help you avoid mistakes, maintain focus, and eventually prosper. The number one worst mistake panicked investors make is turning a temporary portfolio decline into a permanent loss by selling out in an effort to avoid further declines. Any investor whose portfolio is diversified throughout U.S.and international stock markets will eventually recover as the markets begin rising at the end of a bear market. In 10 of the last 11 recessions, the U.S. stock market rallied by an average of 24% during the six months after a recession ended. The sole exception was 2001, when stocks were still overvalued at the recession’s end and had further to fall.
The astute investor carries around a mental checklist of reminders that help him counter the daily drumbeat of bad news that accompanies a bear market. First on the list: the horse is already out of the gate. By the time you think a bear market is in progress, there have already been sharp declines and the market is closer to the bottom. It is simply too late to take cover.
Second: are competing investments the best place for money in the long term? During market panics investors flee to U.S. Treasurys. The heavy buying interest pushes down yields, meaning that new investors will get lower returns over time. Last month, yields on Treasurys fell sharply and new investors had the choice of locking in 10-year notes with yields as low as 3.5%. After inflation and taxes the chance of keeping up with inflation over the next 10 years is very low. Meanwhile, rates on bank deposits and money market funds were falling due to rate cuts by the Federal Reserve.
Third, as scary as the market seems right now, it is actually less risky than it was last year. Yes, a recession will slow corporate profits, but stock prices fall so precipitously in a bear market that they become more of a bargain in relation to future corporate earnings.
Fourth, a diversified portfolio will offer decent returns over the long term. Although losses come at the beginning of the bear market, eventual recoveries boost your long term return so that, looking back a few years after a bear, returns look much better.
You can help your portfolio recover faster by keeping it balanced. Set a target percentage of stocks to bonds and stick with it. When your stock investments fall by some predetermined amount (say, five percentage points below target), it is time to take some money out of fixed income investments and buy stocks. This forces you to buy bargains.
