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It’s a headline that every stock market investor fears will happen.
The markets crash and their hard-earned nest egg evaporates. They’re
forced to go back to work and must resort to eating beans and rice.
Is that fear justified? No.
Stock markets around the world dropped on Tuesday. The news media
echoed that it was the biggest one-day drop since September 11th,
2001. The Chinese stock market dropped almost 10%. Here in the U.S.,
the major indexes were down over 3%. At one point the Dow Jones
Industrial Average dropped over 150 points in one minute!
Should investors panic? No. The world is not coming to an end. The
world’s economies continue to be strong and are growing. Interest
rates are still low compared to historical standards. And
yesterday’s decline follows 7 months where the markets recorded
increases of 15%, 25%, 40%, and even 77%.
First, let’s put yesterday’s drop in proper perspective. I remember
watching the ticker back in 1987 when the stock market tumbled. It’s
something that I will never forget and is one of the reasons I have
developed the systems and strategies I use to manage my client’s
money today.
On Tuesday the Dow Jones Industrial Average dropped a little over
400 points. To equal the market drop in 1987, Tuesday’s total
decline would need to be 2700 points. Tuesday, the Dow dropped 3%.
In 1987 it dropped around 20%!
Second, there are going to be times when the markets make rapid
adjustments. This applies not just to the stock markets, but to bond
and real-estate markets as well. The introduction of electronic
trading and the proliferation of hedge funds only add to volatility.
That may have been what occurred yesterday. Hedge funds can be
leveraged as much as 30:1. That means if they have one dollar, they
borrow thirty dollars more and invest it all. If the markets go up,
a hedge fund can make enormous returns. If the markets drop too much
then they get a ‘margin call’. That’s when those that lent the money
decide they want it back—right away.
When someone trading on margin receives a margin call, typically
they have to sell investments to generate the cash needed to cover
the call. When you’re leveraged 30:1, it means you have to sell a
lot of investments. Hundreds of millions of dollars can be sold in a
matter of minutes with the use of electronic trading. That selling
causes the market to go down, which causes others to receive margin
calls. So they then have to sell.
Many of today’s mutual fund managers haven’t experienced a decline
like 1987 or 2001. Initially, they hang in there. But as the markets
drop further they succumb to the fear and decide to start dumping
investments. In my opinion, that’s why the sell off picked up speed
Tuesday afternoon.
That brings me to my second point. Who’s watching your money? When
things go bad they can go bad in a hurry. That’s why it is so
important that you know there is someone who is closely monitoring
your money and will take action if necessary to protect it.
Unlike most managers, I employ multiple strategies in each account.
Some are short-term, some medium term and others long-term. Days
like yesterday illustrate the benefits of this multi-strategy
approach. The money in short-term strategies was quickly moved to
cash. Some sales actually took place the day before the big drop.
Others occurred shortly after trading started. If 25% of an account
is quickly moved to cash in such instances, that reduces the overall
risk to the portfolio substantially.
Third, it’s important that you be selective in what you sell.
Liquidating short-term positions allows me to hold on to
high-dividend paying stocks and other investments that should
comfortably weather the storm. Even if the market languishes, I hold
strategies that pay dividends of 6-9%.
Lastly, after the market closed yesterday I saw a picture of a U.S.
soldier carrying an Iraqi child needlessly killed. I talked with a
client who was undergoing additional testing to see if she has
cancer.
While it’s my job to monitor and manage my client’s money and your
job to safeguard your nest egg, it’s important to remember in the
end, there are things in life that are much more important than
money.
Nationally-syndicated financial columnist and Certified Financial
Planner® Jeffrey Voudrie provides personal, in-depth money
management services and advice to select private clients throughout
the USA. He’ll answer your financial question – FREE at
www.guardingyourwealth.com.
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