Is it Time for Investors to Panic?

Talk about an inauspicious start…

The market stumbled out of the gate this year like a drunk leaving his favorite saloon at closing time. Virtually every sector is down. So are most overseas markets.

Many market pundits now claim this is it, the beginning of the long-awaited bear market. Is it time to panic?

Of course not.

[ad#Google Adsense 336×280-IA]Panicking is for when a toddler in your charge suddenly darts into the street.

It has no place in portfolio management.

Let’s do a reality check here.

Trees don’t grow to the sky and stocks don’t rally in perpetuity.

History shows that every bull market is followed by a bear market.

And that’s okay, because every bear market is followed by another bull market.

The market’s long-term trend is higher highs and higher lows.

As for all those confident market prognosticators, recall what Peter Lynch, the legendary manager of the Fidelity Magellan Fund, wrote in his investment classic One Up on Wall Street:

Thousands of experts study overbought indicators, oversold indicators, head-and-shoulder patterns, put-call ratios, the Fed’s policy on money supply, foreign investment, the movement of the constellations through the heavens, and the moss on oak trees, and they can’t predict the markets with any useful consistency, any more than the gizzard squeezers could tell the Roman emperors when the Huns would attack.

Almost without exception, the folks proclaiming the end is nigh have a long history of making similar predictions. And all they have to show for it – aside from a complete inability to feel embarrassment – is the yolk running down their faces.

As Vanguard founder John Bogle often notes, there are two types of market timers: Those who don’t know what they’re doing and those who don’t know they don’t know what they’re doing.

Remember that the next time you hear some CNBC contributor confidently pronouncing what the market is likely to do next.

Given the uncertainty inherent in financial markets, what does a sophisticated investor do?

  1. He makes a workable plan in advance.
  2. He responds unemotionally to market volatility.
  3. He sticks to his discipline.

Take a long-term investor, for example. He knows that bull and bear markets are a fact of life. So he sets an asset allocation and sticks with it. That means every year he sells down the assets that have appreciated the most and adds to those that lagged the most.

(Again, I’m referring to asset classes – equities, bonds, real estate investment trusts, Treasury inflation-protected securities, etc. – not individual stocks. You most definitely should NOT add to the worst stocks in your portfolio.)

Rebalancing doesn’t just reduce portfolio volatility. It forces you to sell what’s high and buy what’s low. That gooses annual returns.

A short-term trader, on the other hand, uses a different sell discipline. In the case of The Oxford Club, it means using trailing stops. That protects your profits in the good times and your principal in the bad.

However, you must actually implement them rather than simply imagine you will. Some investors so detest taking small, short-term losses that they end up with big, long-term losses instead.

Not good.

Occasional losses are a fact of life. That means you must be capable of acting resolutely and unemotionally. If you can’t do this, you may need to turn your portfolio management over to a trustworthy, low-cost investment pro. (As Harry Callahan famously said, “A man’s got to know his limitations.”)

Understand that I’m not suggesting you shouldn’t feel emotional occasionally. That’s too much to ask of flesh-and-blood human beings when financial markets come unbound from time to time, as they will.

But you can’t act on those emotions and expect to prosper.

It may seem simplistic to some that you need only have a workable plan, respond unemotionally and stick with your discipline.

But history demonstrates that the key to long-term investment success is not doing something absolutely brilliant. It’s not doing something terribly foolish.

Good investing,

Alex

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Source: Investment U