Help! The Market Is Down
How much should you care about market dips?
If You're a Long-Term Investor
If you are more than 10 to 15 years from retirement and investing for the long term, you probably don’t have to worry about what the market does on a given day. The key to long-term investing is defining your risk tolerance beforehand and building a portfolio that you are comfortable with. It’s called asset allocation, and once you have settled on it, you need not worry unless your allocation gets completely out of whack.
A lot of financial professionals will tell you that asset allocation and regular portfolio rebalancing is the best long-term strategy. I like it because there’s less fretting involved. Instead of randomly following the market, you can set a date once a year to check in and see if your portfolio is still in line with your goals. If not, then rebalance.
Rebalancing involves selling winning investments to put more money into investments that have gone down, also known as buying low and selling high. Say you have a portfolio that’s 70 percent stocks and 30 percent bonds. If bonds have a great year and stocks fall, your balance will change. If bonds begin to represent 37% to 63% for stocks, you can move more money into stocks to rebalance. If you are following this strategy, you don’t really pay attention to the market for the rest of the year. Ups and downs will happen, but if your asset allocation is on target, you can ride out market swings.
If You Are a Near-Term Investor
Even if you are close to retirement, your portfolio allocation should reflect that. You may have a greater percentage in fixed-income or dividend-paying investments in an attempt to increase the income that your portfolio produces. But once you have an allocation that works for you, the rebalancing strategy is the same. You may want to check in on your portfolio more often than once a year. Or you may decide to make a move if the market goes down more than a set percentage. This is known as a trigger.
Some brokerages offer to contact you in the event of a trigger, so you don’t have to think about it until then.
Are there rules of thumb for asset allocation? The old trick of subtracting your age from 100, putting your age in bonds and the rest in stocks, may work for conservative investors. But how much risk you want to take with stocks will really depend on your own appetite for growth and tolerance for risk. You can find many risk tolerance calculators on the Web, and your 401(k) administrator probably has some tools to help you. You can also consider whether you want to keep the stock portion of your portfolio in one broad market index fund or divide your holdings between mutual funds or ETFs that represent different market segments and sizes, and individual stocks.
Long-term investors are probably better off with mutual funds or ETFs because you don’t have to worry about the volatility of a single stock. If you have company stock, there are ways to build a diversified portfolio around that position, but you should probably discuss it with a financial advisor or investment professional.
If You Are a Short-Term Investor
There are those people who enjoy paying attention to the stock market. Most people don’t. But if you do really love it, you might make money buying and selling individual stocks and other securities. I’m all for this, but don’t risk your retirement money on this type of investing until you are very sure of yourself (and maybe not even then). Build a “fun money” portfolio for stock trading.
Active investors do pay attention to daily market moves and try and time the market. But investors who have the most success typically buy rather than sell on market dips. Of course, this all depends on the health of the company, and active traders should learn how to analyze stocks based on their fundamentals. If a company has strong long-term prospects and is a good value, buying it when it’s cheap is like finding a great bargain.
Real day traders have all sorts of tricks, like shorting stocks and making a lot of intra-day moves. Again, unless you really know what you’re doing you could lose a lot of money attempting this (and even when you do know what you’re doing), especially if you use leverage, or debt, to trade equities. There are also tax consequences to these trades.
The bottom line for retirement investors: unless the circumstances are extreme (2008 anyone?), most of us don’t need to pay much attention to short-term market moves. If you have an asset allocation you can live with, you can ignore the financial headlines.
Disclosure: The content on this site is provided for information and discussion purposes only, and should not be the basis for your investment decisions. Under no circumstances does this information represent a recommendation to buy or sell securities.