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What to Do When Stocks Decline Justus Morgan |
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Five
years of gains in the stock market may have finally come to an end. This year
is off to a rough start with losses of six percent for the S&P 500
through the end of January. A number of factors are driving the sell-off
including a slowing economy, belt tightening by lenders and continuing
declines in the real estate market. While
technically we are not in a bear market yet (defined as a stock market price
decline of at least 20 percent), it may be coming. Instead of trying to
predict where the market is headed next, I’d rather talk about several
strategies to minimize the impact of a declining stock market. First, do
not let your emotions guide your investment decisions and sell out of fear. Unfortunately,
nothing feels better emotionally now than doing what would be the wrong thing
financially. When emotions take over, the undisciplined investor sells at
market lows because it feels good to be out of the market -- following the
herd is more comfortable during times of fear and uncertainty. When stocks
start to rise towards new highs, again the undisciplined investor, not wanting
to miss out on further gains, succumbs to possible greed and buys towards the
top of the market. Both of these emotional responses violate the “buy low,
sell high” mantra. By appeasing short-term emotions, we compromise long-term
financial security. Second,
do not get caught in the downward spiral of trying to time the market of when
to buy and sell. Since we cannot predict when the market will go down nor
when it will increase again, the objective is to remain appropriately invested
based on your situation. Over the past 80 years, the average bear market (based
on the S&P 500) lasted less than two years. Occasionally (four times in
80 years) we’ve experienced a protracted bear market -- declines that
continued for successive years. During
this period of time, stocks averaged returns of more than 10 percent. During the
same period of time, government bonds averaged just over 5 percent. Stocks
are already risky enough. Adding market timing increases risk and requires
investors to be right twice, when to sell and when to buy back in. Third, if
you receive income from your portfolio, we recommend you hold six to nine
years worth of portfolio distributions outside of the stock market in cash or
bonds. This provides a “safety net” of secure investments to weather the
market declines and wait for the recovery which inevitably follows the
losses. As long
as you don’t take risky bets of concentrating your money in individual stocks
which can see their value drop to zero due to bankruptcy, a diversified
portfolio will eventually recover. We have
many long-time clients who experienced the last protracted bear market from
2000 to 2002. During that time, we faced difficult choices and decided not to
sell equities. Those clients were rewarded with five positive years of gains
which erased the losses and set new highs. Inevitably, the market will go
down again and now it has. Just as in the past, we expect a full recovery.
Unfortunately, we do not know when this will come. Justus
Morgan is a Certified Financial Planner with Financial Service Group, Inc., a
registered investment advisory firm in |