Four investment fundamentals can help you survive - and perhaps even take advantage of - a market decline.
When the stock market is rising, many investors become complacent. They generally ask just one question: What should I buy?
But when the market is declining, they urgently seek answers to a whole new set of questions: What should I do now? Should I hang in there? Sell everything and move to cash? Is this a buying opportunity? Should I temporarily move to the sidelines and then jump back in when the stock market turns around? How long is this down market likely to last?
Market declines can be unsettling and even downright scary. At some point, you too may have asked these important questions. But here’s another question we hope you’ve also asked - or will ask - your financial adviser: Can you help me construct a financial program that will stand the test of time and help me reach my long-term goals?
If you and your financial adviser have already done that, you probably also know the answers to the questions we posed above. So, what should you do now? The answer for most people who have set up a long-term plan is - nothing. An investor confronted with a declining market should do nothing that will upset his or her long-term investment program.
Get Back To Basics
Market declines always present an opportunity to find out how solid your financial program is. If there’s a weakness, it will show. That’s why this is a good time to revisit four basic investment fundamentals that can help you survive a down market - and perhaps even take advantage of it.
Diversify
It’s a good idea to spread your risk by investing in a carefully selected mix of mutual funds that invest in stocks, bonds and money market instruments. It’s also wise to consider diversifying into an international or global fund. Although events in the U.S. stock market have an impact around the world, other countries move in different economic and market cycles. So while your U.S. stock funds may show losses in a U.S. bear market, diversified international funds may lose less or even show a gain.
Keep a Long-Term Perspective
Remember that time in the market is important - not timing. Even diversified investment portfolios can lose ground in a bear market, and it’s easy to be tempted to sell all your stock funds and move to money market accounts to wait for better times. All you have to do then, the reasoning goes, is move back into stock funds on the day the stock market begins its recovery.
The problem is, nobody knows when that day will be. And if you miss getting back in at the right time, you can lose a huge portion of your profits. If you invested $10,000 in Standard & Poor’s 500 Stock Composite Index and missed just the 10 best days in the 10-year period ended December 31, 1999, your return would have been 41% lower than if you had remained in the market the entire time. That means if you had stayed the course, your original $10,000 would have grown to $41,575 in those 10 years, without dividends reinvested. If you missed those 10 best days, you would have had only $28,557.
Invest in Bad Times and Good
One of the best ways to invest regularly is dollar cost averaging. This strategy calls for investing the same amount at consistent intervals, such as once a month or every quarter. With this approach, you don’t have to try to guess which way the financial markets will move - and you won’t be waiting around for the perfect time to buy.
Although it doesn’t guarantee a profit or protect against a loss, dollar cost averaging is also one way to take advantage of a down market. Since you are investing regularly, you end up buying more shares when the price is down. Instead of seeing a down market as a disaster, view it as an opportunity to buy good companies at lower prices through your mutual funds. Of course, to make this strategy work, you have to be willing to continue making investments when stock prices are declining and stock market news is negative.
Don’t Forget Dividends
Even though most company share prices will be impacted by a bear market, this doesn’t mean that the companies themselves are faring poorly. Many companies continue to pay dividends at the same rate during a bear market. So although your stock or mutual fund prices may be lower, your dividends may well continue at the same rate.
Market Declines Are Natural
Finally, let’s take a look at a few facts that might help put market declines in perspective. After all, like the seasons, they are a natural part of the landscape. Since 1900, there have been 285 “routine declines” of 5% or more in the stock market, 91 “moderate corrections” of 10% or more, 43 “severe corrections” of 15% or more and 26 “bear markets” of 20% or more. Declines are part of being in the stock market.
So, even if you haven’t lived through a tough bear market, you’ve probably seen a lot of volatility. If you’ve chosen a good financial adviser who has been through market declines, you should be in good shape to withstand the next down market too.