Last Updated: January 1, 2008
It's been a wild week on Wall Street. When trading reopened on Tuesday after the Martin Luther King holiday, the Federal Reserve Board responded to world pressure and swooped in with a rate cut to put a floor on Dow losses that were approaching 20 percent since last October. By today, things seemed to be stabilizing.
But what about tomorrow? And then next week, and the weeks after that?
If this question fills you with worry, then it's pretty clear you're operating without a plan, or at least one you haven't recently checked. That's OK. When worldwide market worries surface, it's easy to get scared. It's particularly easy when we've had such major market calamities as the U.S. mortgage debacle and the lingering disarray in the banking and investment industries.
But sudden action is usually a mistake. In the late 1980s, Harvard psychologist Paul Andreassen made news with a research project that found that people who listened to market news actually made lower returns. Why? Because those who sold – or bought – during a market swing probably found a day later that the market was really running on hype, not fundamentals.
You pay a financial planner to devise a financial strategy that matches your risk tolerance and long-term financial goals. No, there is absolutely no way to guarantee that you'll never lose money. But if a plan truly matches you, the noise shouldn't make a difference, particularly if you don't need the money today.
So the next time world markets spike or slide, ask yourself:
What's my plan? If you've worked with a financial planner, you should be able to articulate those goals all by yourself or refer to an investment policy statement you made together. Much of the riskiest investing, overbuying and panic selling during the late 1990s and early 2000s could have been avoided if individual investors had sought advice for achieving long-term specific goals such as retirement or a college education. Find a planner.
What's my risk tolerance? At your first meeting with a planner, you should have discussed a number of questions about how you handle risk and what your expectations were about investment returns. You might have had to do this more than once if your risk tolerance was low but your investment expectations were high – low-risk investors can't expect the highest returns. That's part of the education process when you visit a planner.
Am I prepared to stay invested – no matter what? We all remember the "Tech Wreck" of 2000. At the worst of that downturn, investors bailed out of the stock market or drastically cut back, only to get back in after they were "convinced" that the market was rebounding. In reality, they missed out on stock market gains during the early stages of recovery, and that's costly in the long run. Of course, some investors looking for that late 20th century investment high also got into the real estate market, and they perhaps learned a similar lesson when that market started heading south two years ago.
In 2004, SEI Investments studied 12 bear markets since World War II. Investors who either stayed in the market through its bottom, or were fortunate to enter at the bottom, saw the S&P 500 gain an average of 32.5 percent (not counting dividends) during the first year of recovery. Investors who missed even just the first week of recovery saw their gains that first year slide to 24.3 percent. Those who waited three months before getting back in gained only 14.8 percent.
Am I diversified? The NASDAQ lost 39 percent of its value just in 2001 and another 21 percent in 2002. Meanwhile, real estate investment trusts, which performed poorly in 1998 and 1999 when stocks were booming, had banner years in 2000 and 2001, performed so-so in 2002 and had an excellent 2003. Bonds also returned well during the bear market. Your planner, based on your risk profile, should have you in diversified investments that fit your goals.
Do I still feel the same way I used to about returns? Having a long-term investment plan doesn't mean make the plan and leave it to gather dust. You and your planner are a team. Both of you should talk and decide when it's time for a detailed review of your investment goals and whether or not they should change. An annual conversation makes sense if nothing's going on, but life events like death, divorce, kids moving out, and illness are good reasons to do a head-to-toe review of a financial plan.
If you're worried this week, there's no reason why you shouldn't call your planner to calm your nerves and confirm what you're doing. And if you've never talked to a planner before, now might be a pretty good time to start.