Finance Globe

U.S. financial and economic topics from several finance writers.
8 minutes reading time (1639 words)

Stock Market 2008

Think things through before you panic out of the market at a loss.
These days, the market's been taking investors on a pretty scary ride. Many of us watch helplessly as the value of our investments fall, recover a little, and then drop some more. Times like these can really test those nerves and bring doubt to any one's well thought-out investment strategy. And though many of us probably wish we had the insight to cash out last October when the market peaked, it would have taken a crystal ball (one that works!) to know to do that.

But what now? There's so much conflicting information out there right now. Some say it's going to get a lot worse before it gets better, so sell and cut your losses now before your investments lose any more value. Some say hold on to your investments - selling now will only turn those paper losses into real losses. But there's no one answer for everybody. Each individual must look at their own tolerance for risk, their investment timeline before they need the money, and whether they really believe that this bear market is going to lead to something we haven't seen since the Great Depression.

Emotions shouldn't really have anything to do with one's finances - which should amount to simple mathematics. But it's difficult for many people to keep their emotions from influencing their mathematically-sound financial decisions, in at least some way. Fearful of losing their life savings, anger at the institutions that let all this happen, doubtful of their investment decisions, and regret for not being able to predict the future. People are very emotional when talking about what they think their holdings will be worth when the dust settles. And why shouldn't they be? Consumer spending is down, unemployment is up, borrowers are over-extended, and massive companies are going out of business - and that's just a start.

It's important to remember that the market reflects both real problems, as well as the fear that it may be worse than we know about. The unknown is scary. But it works the other way, too. Before every downturn, there is real growth during a bull market, plus the over-confidence that the growth will continue beyond what's reasonable. Investors jumping into the frenzy continue to push the prices up even when they are already overvalued. Then some bad news comes up, investors panic and sell, and prices plummet - and the stock of sound companies often suffer beyond what is reasonable. The old investing cliche of "greed and fear" is the simplest way to describe the cause for the extreme, and unpredictably wild swings of the market in both directions.

Bear markets often come with the widespread fear that "This time is different," "This time is worse than the last," or "This time, the world as we know it is coming to an end." The world wouldn't be complete without the pessimists who help us take into consideration the worst possible scenario - it keeps us on our toes. And though it's true that this time may be pretty bad, the market has always recovered in the long-term.

Good asset allocation will help reduce the risk.
It's easy to plow money into the market when times are good and even shaky investments are making money, but a market downturn can have an aggressive investor wondering if they've taken too much risk. A younger investor who has many years to retirement is generally advised to invest fairly aggressively, which mean most of their holdings are probably in stocks and stock funds. The younger investors with larger stock holdings, in general, have taken a larger hit to their portfolio in the past year, but they probably also have many more years and paychecks to recover from it.

Now those nearing retirement, or those who need their money within five or ten years, shouldn't have had very much of their money in stocks before the downturn, if they have any at all. The conservative investor who has wisely researched their investment choices and carefully rebalanced their portfolio each year, with a larger portion in cash and bonds, should not have suffered as drastic a blow to their holdings as the aggressive investor.

The "Buy and Hold" School of Thought
Since we can't accurately guess when the market will hit its peak or bottom, many professional money managers advise investing for the long-term, no matter what the market is doing. Successful market-timing is impossible for any one to do on a consistant basis, and it often backfires to leave the investor with less than they would have had if they stayed in through the market's ups and downs. The stock market has historically returned about 10% annually, making stocks the best long term investment. Remember that though it's no guarantee, the past is all we have to give us any indication of what may happen in the future.

For the long-term investor, many experts recommend that you try to ignore most of the information in the paper, on the news, and on the Web that may tempt you to alter your investment strategy. It may be tempting to sell when the market is on the way down, hoping to get back in at a lower price - but figuring out when to get back in is a guessing game. Selling now locks in your losses, and you may even end up buying back in at a higher price if you don't catch the turnaround quickly enough - increasing your loss even more than if you had just stayed put to begin with.

Bear markets are an opportunity to grow your portfolio at a lower cost-per-share. Financial guru and author Dave Ramsey recommends continuing to make regular contributions to long-term investments, and points out that good stocks are on sale now. Remember, profitable long-term investing means buying low and selling high, just the opposite of what many panicked investors do.

Another benefit to long-term investing, in addition to the lower average cost-per-share, is that it keeps you invested through the markets' unpredictable changes - ensuring you'll be in the game when the market does turn around. Staying in through the hard times can take some solid discipline, when it seems like many people you talk to may have cashed out at a loss out of fear of losing more. It's difficult to know when the market's hit bottom until it's making an obvious recovery - and by that time, many investors who attempt to time the market will likely have missed out on the best days of growth, since the recovery often happens fairly quickly.

The "Get Ready for the Worst" School of Thought
Conversations with others reveal that many believe that we are still in the early stages of something much worse to come. Many who fear the worst have already pulled their money out of the market to wait for better times. Older folks who can't afford to have their retirement savings evaporate into thin air are probably wise to do so - it's better to know your money will be there when you need it.

Comparisons to the 1929 stock crash preceding the Great Depression are becoming more common in the media. While there are similarities to be considered, there are also notable differences that we hope will change the outcome of the current financial crisis. (I'll cover some of those points in the next article.) But only you can make the right decision for your money. If you're going to lose sleep over it at night, and you'd rather take the risk of settling for what your holdings are worth now than to take a chance they'll soon be worth less, then put your assets into something safe, like a CD or money market account.

Host of CNBC's "Mad Money" Jim Cramer warned that you should pull any money you need within five years out of the market right away. I applaud him for warning investors that economic and market recovery may take a while, but the truth is, that you should never put money into the stock market that you need in the near future, no matter what the market is doing.

So if you somehow ended up with some of your immediate-need cash in the market, take it out so you won't have to add a pile of debt to your financial situation through the economy's recovery. And then, do some research on the importance of asset allocation for your risk tolerance and timeline, and be sure that you keep your next investments geared to your true needs and desires.

The current market situation is precisely why most experts say that you should only invest what you won't need in the near future. And to take it a step further, some experts also say that you shouldn't have any money in stocks that you can't afford to lose. Not very encouraging, but it helps to put things in perspective - there's always the chance that it could all be lost. If you just can't bear that kind of risk, keep your money out of the stock market.

Research some more and then do what feels right to you.
So do your research, evaluate your financial goals and plan, crunch some numbers, and make decisions according to your need for growth and your tolerance for risk. Trust your instincts. Make it a priority to pay your debt down, save some extra cash, and enjoy the simple things in life - like walking your dog, playing with your kids, or visiting your parents. The economy will take some time to recover, but its recovery will be stronger if each individual makes smart decisions now for their own financial well-being.

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Monday, 27 May 2024

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