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Everyone wants to invest in the stock market when it’s going up. The
key to successful stock market investing isn’t how well you do
during the good times, but how you handle the bad times. Read on to
learn ways you can reduce your market stress without jumping ship.
The returns associated with investing in the stock market the last
several years have been spectacular! The Dow Jones Industrial
Average surged 72% between February 2003 and May 2007. It powered
ahead 22% in the ten months ending in May ’07. This ‘bull’ market is
double the length of most, now at four years and counting.
During such great times, it’s easy to forget that the stock market
can go down. One day in February saw the DJIA drop over 4%. Last
week saw all the major averages decline significantly, some of them
wiping out all the gains they had accumulated for the year. With the
bear market of 2000 – 2002 still fresh in many investors’ minds,
it’s easy to see why someone might panic in the midst of such a
quick, sharp decline.
Your actions during the ‘panic’ times in the stock market will
determine your overall success. Professional investors don’t react
emotionally to market events. They know that small investors usually
do. As a result, it’s the perfect time for the professionals to buy
stocks on sale when the small investors run for the exits.
That doesn’t mean you should sit by and do nothing. Personally, I
don’t believe ‘hope’ is a reliable stock market strategy! Instead,
you need to prepare ahead of time for the tumultuous times that are
sure to happen. Here are some simple steps you can take.
Step 1: Determine the amount of money you are willing to lose. While
none of us want to lose money, you can’t participate in the gains if
you aren’t able to stomach the periods of decline.
I’ve found that there is often a big difference between the amount
someone rationally thinks they are willing to lose when they set up
an account and how they react emotionally when a loss occurs. This
number should be based on your emotional tolerance, not your
rational tolerance.
I believe it’s also important to convert this number to a
percentage. Imagine how you would feel if you lost $70,000! Yet, if
you have $2 million invested, that is a decline of only 3.5%,
something very likely to occur. If you focus just on the dollar
amount you are going to greatly increase your stress.
Step 2: Determine your overall approach to managing risk. The common
approach in the industry is to spread your money between bonds, real
estate and equities (both foreign and domestic). The thought is that
since these normally move in opposite directions that they will
balance each other. This is referred to as Asset Allocation. It’s
true to a point, but there are times when it seems like everything
goes down.
Another approach says that you need to hang on during the bad times
because over the long-term stocks should be higher. This is referred
to as Buy and Hold. There is some truth in this as well, but it
doesn’t seem logical to do nothing to prevent large losses from
occurring in the first place.
A third approach says you should actively manage your account. This
is normally done by using various algorithms or indicators to
determine when to buy and when to sell. If the market starts going
down your money gets moved to cash. But this doesn’t always work and
may result in missing some big gains.
None of these approaches are perfect. That’s why I don’t rely on any
one of them. Instead, I utilize all of them together! I use
short-term, medium-term and long-term strategies in the same
account. If the market starts going down, the short-term typically
gets moved to cash pretty quickly. That often reduces the risk
enough that the medium and long-term positions can be held on to
through the storm.
Step 3: Trust your plan. The temptation is to throw caution to the
wind. Don’t.
These are just a few of the steps I use in my clients’ accounts.
Taking them won’t guarantee smooth sailing, but chances are they
will help you survive the storm intact.
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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