|
Resources
7
Lessons To Learn From A Market Downturn
by
Stephanie Powers
You
can never really understand investing until you weather a market
downturn. The valuable lessons learned can help you through
the bad times and can be applied to your portfolio when the
economy recovers. Listed below are some common investor experiences
during tough economic times and the lessons each investor can
come away with after surviving the events.
Lesson
#1: Evaluate Your Egg Baskets
You're
pulling your hair out because everything you invest in goes
down. The lesson: Always keep a diversified portfolio, regardless
of current market conditions.
If
everything you own is moving in the same direction, at the same
rate, your portfolio is probably not well diversified, and you
could stand to reconsider your asset-allocation choices. The
specific assets in your portfolio will depend on your objectives
and risk-tolerance level, but you should always include multiple
types of investments.
Taking
a more conservative stance to preserve capital should mean changing
the percentages of holdings from aggressive, risky stocks to
more conservative holdings, not moving everything to a single
investment type. For example, increasing bonds and decreasing
small-cap growth holdings maintains diversification, whereas
liquidating everything to money market securities does not.
Under normal market conditions, a diversified portfolio reduces
big swings in performance over time.
Lesson
#2: No Such Thing As A Sure Thing
That
stock you thought was a sure thing just tanked. The lesson:
Sometimes the unpredictable happens. It happens to the best
analysts, the best fund managers, the best advisors, and, it
can happen to you.
The
perfect chart interpretation, fundamental analysis, or tarot
card reading won't predict every possible incident that can
impact your investment.
| · |
Use due diligence to mitigate risk as much as possible.
|
| · |
Review
quarterly and annual reports for clues on risks to the company's
business as well as their responses to the risks. |
| · |
You
can also glean industry weaknesses from current events and
industry associations. |
More often,
an investment is impacted by a combination of events. Don't
kick yourself over unpredictable or extraordinary events like
supply-chain failures, mergers, lawsuits, product failures,
etc.
Lesson
#3: Proper Risk Management
You thought
an investment was risk-free, but it wasn't. The lesson: Every
investment has some type of risk.
You can
attempt to measure the risk and try to offset it, but you must
acknowledge that risk is inherent in each trade. Evaluate your
willingness to take each risk.
Lesson
#4: Liquidity Matters
You always
stay fully invested, so you miss out on opportunities requiring
accessible cash. The lesson: Having cash in a certificate of
deposit (CD) or money market account enables you to take advantage
of high-quality investments at fire sale prices. It also decreases
overall portfolio risk. Plan ahead to replenish cash accounts.
For example, use the proceeds from a called bond to invest in
the money market instead of purchasing a new bond.Sometimes
cash can be obtained by reorganizing debt or trimming discretionary
spending. Set a specific percentage of your overall portfolio
to hold in cash.
Lesson
#5: Patience
Your account
balance is lower than it was last quarter, so you overhaul your
investment strategy before taking advantage of your current
investments. The lesson: Sometimes it takes the market an extended
period of time to bounce back.
Your overall
portfolio balance on a given date is not as important as the
direction it is trending and expected returns for the future.
The key is preparedness for the impending market upturn based
on an estimated lag time behind market indicators. Evaluate
your strategy, but remember that sometimes patience is the solution.
Lesson
#6: Be Your Own Advisor
The market
news gets bleaker every day - now you're paralyzed with fear!
The lesson: Market news has to be interpreted relative to your
situation.
Sometimes
investors overreact, particularly with large or popular stocks,
because bad news is replayed continuously via every news outlet.
Here are some steps you can follow to help you keep your head
in the face of bad news:
| · |
Pay attention and understand the news, then analyze the
financials yourself. |
| · |
Determine
if the information represents a significant downward financial
trend, a major negative shift in a company's business, or
just a temporary blip. |
| · |
Listen
for cues the company may be downgrading its own expected
returns. Find out if the downgrade is for one quarter, one
year or if it is so abstract you can't tell. |
| · |
Conduct
an industry analysis of the company's competitors. |
After
a thorough evaluation, you can decide if your portfolio needs
a change.
Lesson
#7: When To Sell And When To Hold
The
market indicators don't seem to have a silver lining. The lesson:
Know when to sell existing positions and when to hold on. Don't
be afraid to cut your losses. If the current value of your portfolio
is lower than your cost basis and showing signs of dropping
further, consider taking some losses now. Remember, those losses
can be carried forward to offset capital gains for up to seven
years.
Selective
selling can produce cash needed to buy investments with better
earnings potential. On the other hand, maintain investments
with solid financials that are experiencing price corrections
based on expected price-earnings ratios. Make decisions on each
investment, but don't forget to evaluate your overall asset
allocation.
Conclusion
Downward
stock market swings are inevitable. The better-prepared you
are to deal with them, the better your portfolio will endure
them. You may have already learned some of these lessons the
hard way, but if not, take the time to learn from others' mistakes
before they become yours.
|