The Impact of Stock Losses

Racine Journal Times / August 2008

Justus Morgan

The ongoing decline in the stock market has generated significant anxiety and fear among investors. Today’s article highlights the nervousness felt by many as well as the discouragement for those still saving for the future. While it’s impractical to offer specific recommendations for you, hopefully you can relate to one of our two hypothetical investors, Nervous Nelly and Eager Eddy.

Nervous Nelly is an aging widow relying on her portfolio for income and loses sleep at night over the thought of running out of money. While she doesn’t like to see her account decline in value, she also recognizes she needs some growth to overcome higher expenses due to inflation as she gets older. Nelly has suffered losses during the turbulent market conditions of the past year and is understandably concerned.

The first step for Nelly is to make sure her overall investment allocation is not concentrated in any one particular company. Just because she worked thirty years for the same company, does not mean her financial well-being should continue to be dependent on the fortunes of one company.

In addition, she should review how much she has in stocks versus bonds. This decision alone will determine most of the gains and losses Nelly may experience in her portfolio. A sufficient amount of money outside of the stock market will allow Nervous Nelly to weather through the decline without the need to sell stocks at a loss yet still provide her with regular income.

Once Nelly has an understanding of her stock and bond allocation, the next step is to compare each of her investments to a benchmark that tracks similar investments. The investment research company, Morningstar provides an excellent starting point for this type of analysis at www.morningstar.com. If there is a wide discrepancy between the investment’s performance and its benchmark, Nelly will then want to figure out the cause for this diversion.

If Nelly is not satisfied with the answers she finds and feels her portfolio is too risky, she may have to take action to reduce the amount of risk by decreasing her stock allocation. Waiting until stock prices recover may only exacerbate the problem because of the uncertainty as to the timing of when this would occur. If the allocation is appropriate, then taking no action may, in fact, be the best course of action.

At the other end of the investing spectrum from Nervous Nelly is Eager Eddy who is a hardworking corporate manager who consistently adds to his retirement account with each paycheck. While Eddy needs to be aware of the same issues as Nelly (single company concentration, stock vs. bond allocation, benchmarking performance), Eddy also has the ability to greatly benefit from the decline in stock values. Eddy can make use of the strategy called dollar cost averaging.

Dollar cost averaging involves investing the same amount of money at regular intervals which allows Eddy to buy more shares with each purchase as the price declines. For instance, $100 will buy Eddy 5 shares at $20 per share but the same $100 will buy him 10 shares at $10 a share. As the price recovers, Eddy will have bought more shares at the lower price which will ultimately increase the amount of his gains.

Unfortunately, as stocks continue to decline Eddy feels discouraged as he sees his account value decline greater than the amount of new money he is investing. Eddy should take comfort in the fact that he is still buying more shares which will provide the foundation for future growth in his portfolio.

Whether you find yourself closer to Nervous Nelly or discouraged like Eager Eddy there are specific actions you can take to help alleviate the anxiety and fear. Similar to physical pain, if the mental stress of seeing declines in your portfolio doesn’t disappear, you may want to seek professional assistance to formulate a strategy specific to you.

Justus Morgan is a certified financial planner with Financial Service Group, Inc., a registered investment advisory firm in Racine, on the net http://www.toyourwealth.com.