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Last week, the stock markets suffered
some of their greatest losses in two years. The Dow was down 3.6%
for the week, the Russell 2000 4.91% and the NASDAQ 5.18%. Many of
the major averages lost close to 2% on Friday alone. How should you
react when the stock market drops significantly? Read on to find
out.
First, let’s look at the big picture to better understand the causes
of this decline. Currently, a host of mixed signals has created
uncertainty over the strength of our economy. Oil prices have
surged, inflation fears have escalated and economic growth has
appeared to slow. Big blue chip companies such as GM and IBM have
reported disappointing earnings.
On the other hand, General Electric released impressive earnings
figures reflecting organic growth of 10%. Citicorp and Wachovia also
exceeded expectations.
As usual, the signals add up to one big question mark. There are no
concrete conclusions you can draw from them one way or the other. So
the questions remain: has our economy hit a soft spot? Is a
recession in our near future? Will inflation fears come to pass?
Will the spike in oil prices spell doom for our economy? Or will all
the bad news just blow- over and amount to nothing?
I wish I had the answers. And the truth is, no one can say for sure.
When in doubt, markets tend to focus on the negative, not the
positive. Markets are very emotional and sometimes end up fulfilling
their own prophecy.
Individual investors are very emotional, too. And therein lies the
problem. Investing shouldn’t be an emotional decision. It should be
a strategic one, with a long-term course of action carefully thought
out and planned for. Changes in long-term strategy should not be
made because of short-term events.
Unfortunately, few investors are able to detach themselves
emotionally from their investments. They fall into a fear/greed
cycle that not only costs them money, but also peace of mind. They
end up worrying needlessly about the natural fluctuations of the
market.
Investors must slay the ghost of markets past. But many allow the
events of 2000-2002 to make them so fearful that they don’t get to
enjoy the benefits of investing in equities. Even small downturns in
the market cause them to lose sleep. They only focus on the negative
and convince themselves the sky is falling. Yet when the markets
trend up, they want to grab all of the gains.
The markets were down significantly most of 2004 but ended the year
up 9%. Those who left the market in fear didn’t have the confidence
to get back in early enough to participate in the gains. Investors
that want to have all of the gains without going through any losses
are going to be very disappointed.
It’s like installing a swimming pool. You know it’s a major
investment and you plan to use it for years to come. What if every
time there was a cold snap or a rainy day, you had a bulldozer come
and fill in the pool? “We can’t use it now. We’ve made a big
mistake!” Then later, when the sun shines again and warm weather
returns, you say, “I need my pool back! Let’s put one in again!”
Obviously, you wouldn’t do such a thing. Weather changes are
expected and planned for. You shut the pool down in the winter and
blow the lines so the pipes don’t burst. You have a solar cover to
hold in the heat during swimming season and chemicals to keep the
water clean and clear. You don’t fill in the pool with dirt every
time something goes wrong. You recognize it is a long-term
investment and you use tools to manage the short-term events.
It should be the same with your investments. Equities are important
to a well-balanced portfolio. Don’t abandon your long-term strategy
just because the market has declined several percent. Make tactical
decisions based on short-term events within the context of your
overall strategy. For instance, I utilize a proprietary portfolio
management system that naturally reduces exposure during declines
and increases it during upward trends. That allows my clients to
pursue the long-term use of equities without losing sleep every time
the market drops.
Got questions? Go to www.guardingyourwealth.com and click on ‘Ask
Jeff’. I’ll answer you personally.
In addition to being a nationally syndicated columnist and Certified
Financial Planning Practitioner, Mr. Voudrie provides personal,
private money management services to clients nationwide.
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