I have long felt the greatest threat to the retirement dreams of most investors can be found in the combination of misinformation promulgated by the securities industry and much of the financial media. Together, they deliver a stream of marketing hype carefully crafted to enrich themselves at your expense.
They seem to go into overdrive when there is an opportunity to create fear and anxiety. The extreme market volatility we experienced last week gave them just such an opening. Their conduct was predictable and unfortunate. The amount of terrible investment advice they managed to disseminate over a short period of time was truly staggering.
If you want to avoid becoming a victim of the industry’s latest machinations, here are some rules you should follow to guide you through a possible market correction.
1. Do a portfolio review. If you are an evidence-based investor, your holdings likely consist of a globally diversified portfolio of low management fee index funds, passively managed funds or exchange-traded funds arranged in an asset allocation suitable for your risk tolerance. If you are not an evidence-based investor, you owe it to yourself and your family to become one.
Becoming an “evidence-based investor” means you acknowledge the overwhelming data, found in hundreds of peer-reviewed studies, that demonstrates stock picking, market-timing and attempts to identify the next “hot” fund manager are discredited strategies. You can find a sampling of these studies at Hill Investment Group’s blog post, “The Weight of Evidence,” which cites many studies showing the limited success of these strategies.
2. Focus on your asset allocation. Here’s all we know about the market in a nutshell. It goes up and down, but over time it goes up. If you are in the correct asset allocation (the division of your portfolio between stocks and bonds) you have positioned yourself to withstand the stomach-churning anxiety that accompanies a market correction.
Here’s an example. Let’s assume you have allocated 50 percent of your portfolio to stocks and 50 percent to short or intermediate-term bonds. In the event of a market correction, you can expect a significant decline in the value of your stock holdings. But your bond holdings should maintain their value. If you need cash, you can sell your bonds to meet your needs. You can hold your stocks until the stock market recovers.
3. Put stock market “losses” into perspective. There is a big difference between an unrealized and a realized loss. An unrealized loss is a paper loss representing the difference between the price of a stock when you purchased it and its current price. A realized loss is an actual loss, represented by the difference between the price of a stock when you purchased it and the price when you sold it.
If you are in the right asset allocation, you will not panic and sell stocks during a market correction, thus converting unrealized losses into realized ones.
Think about it this way. In the stock market crash that began in 2008, the only investors who lost money were those who sold stocks while the markets were declining. If you did nothing and held onto your stocks, you likely profited handsomely from the recovery.
When you have this outlook, you can view both the advice of your broker and the financial news in perspective. Their goal is to get you to take action and “flee to safety,” resulting in increased fees and commissions. But if you follow this advice, you will incur losses and miss out on any recovery in the market.
4. Ignore predictions. None of the financial “gurus” on television have the ability to forecast the future. They can’t tell you whether the market is primed for a retreat or is about to surge. Although they appear supremely confident and well-credentialed, there isn’t any evidence to show anyone has the expertise to accurately make predictions about the future. They don’t have a proven system for picking winning stocks or the ability to tell you what sector will outperform other sectors. Unless you find them entertaining, you should stop watching programs that feature their opinions.
5. Don’t act on impulse. In 15 minutes, I could teach any investor how to capture global market returns. It’s far more difficult, however, to control your emotions when the value of your portfolio is dropping. Acting on impulse is harmful to your financial well-being. How many times have you heard people say things like: “I can’t take it anymore. I sold everything and I’m waiting on the sidelines,” or “It’s clear to me that we are headed for a depression. I’m buying gold.”
Acting on impulse is the opposite of following a well-designed investment policy statement. Especially during periods of market volatility, you need to control your emotions and stay disciplined.
Dan Solin is the director of investor advocacy for the BAM ALLIANCE and a wealth advisor with Buckingham. He is a New York Times best-selling author of the Smartest series of books. His latest book is “The Smartest Sales Book You’ll Ever Read.”
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5 Investing Rules In Case of a Market Correction originally appeared on usnews.com
