“The sky is falling, the sky is falling” cried Chicken Little. Some investors may agree. What should you do If you find the stock market plummeting.
1. Don’t panic. Remember that panic is not an effective, long-term investment strategy. But when the Nasdaq plunges as much as 5% a day for several days running, it’s hard to maintain your cool. So turn off the media, and take a good long look at your long-term investment strategy
2. Don’t let the bears get you down. Abraham Lincoln once said “When you have got an elephant by the hind legs and he is trying to run away, it is best to let him run.” The same thing is true of bears – don’t panic and sell low. Let the bear market run its course, which history tells us is likely to be short.
3. Remember that cash is king. In the bullish past five years, many investors have abandoned their long-term strategy. I’ll just put as much as I can in the market, buy the dips, and come out fine. But that’s not good planning for money you’ll need in the not too distant future. So figure out what you’ll need in the next year or two (or even three), and invest it conservatively in certificates of deposit and short-term bonds. The money you won’t need for ten years or more (your retirement stash) can go into the stock market, because you have time to weather the storms that inevitably come along. And if you have extra cash available, you can take advantage of buying opportunities when your favorite stocks take a tumble.
4. Rebalance your portfolio. Once you’ve figured out what percentage of your portfolio should be in cash, stocks and bonds, adjust your investment mix periodically to meet those goals. One way to do this is to sell investments that have gone up, and invest the money in assets that have gone down. That is counter-intuitive – for example, until this week most people wanted to buy stocks, which have soared, and abandon bonds, which have fallen. But selling bonds and buying stocks would have been selling low (bonds) and buying high (stocks). A smarter strategy is to regularly adjust your portfolio to maintain a steady percentage balance.
5. Add fuel to the fire. The rate at which you save is even more important than the rate those savings earn. Begin investing as soon as you can, invest regularly, be patient, and time will shower your investments with compound growth. When the market dips, you’ll shout hooray, because you’ll get even more shares of your mutual funds with this month’s investment. It’s like buying your clothes on sale at the half-yearly sale. A dip in prices means you can get even more for your money.
6. Don’t expect miracles. Your investment decisions won’t be right all the time, and some of your funds will underperform your expectations. That doesn’t mean you are a bad investor, you just aren’t perfect (oh, darn). Rebalance and weed out consistent underperformers over the years, and you will generally achieve a reasonable overall investment return. And remember, just because the Nasdaq made 85% last year, that doesn’t mean a well-balanced portfolio will have made that much. If you earn 10% – 15% overall, year after year, you’ll do well.
7. Buy and hold, don’t cut and run. Don’t change mutual funds every year to acquire last year’s hot performer. It may be a flash in the pan, and to buy it you may dump a good long-term investment, tossing it from the frying pan into the fire and missing the sizzle altogether. Rarely does last year’s top performer become this year’s top performer, and frequently it doesn’t even make the top ten. Pick funds that have done reasonably well, year after year, in down markets as well as up. You don’t have to own the very best funds, just avoid the very worst ones and you’ll do well.
8. Cut the IRS off at the pass. Invest as much as you can in tax-deferred retirement plans, such as 401(k) plans. Your money will grow faster and you can afford to invest more now because you won’t have to pay taxes on the money until you retire. And if your income is under $150,000 ($95,000 if you are single), put $2,000 into a Roth IRA each year. If you leave it alone it will grow over the years, and you won’t have to pay tax on the money when you take it out.
9. Don’t multiply, diversify. Recently I’ve consulted with many people who have exercised stock options over the past year or two. They took the proceeds and invested them, but often in the same type of technology and internet-related companies they work for. That is not diversification, that’s multiplication – your eggs aren’t in the same basket, but they are still on the same shelf. If that shelf teeters, there go your eggs.
10. Ask the experts. Seek professional help if you need it. Even if you are a do-it-yourselfer, consider a periodic checkup with a financial adviser to hone your portfolio’s performance. And if your circumstances change drastically, it’s time to consult a professional to make sure that you are on the right track. This applies to those who inherit money, sell businesses, or exercise stock options. It also applies to those who suffer sudden reversals of fortune as well. The path you were on before may well not be the right path for your future.