Reducing Market Stress

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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