There is no way around it — markets generally move in cycles!
Although the past is no guarantee of the future, historically, the stock market has spent more time on bullish advances than on bearish retreats — which is why stocks have been considered a good investment over the years — the market also tends to retrench more than the average investor would like to think about. The traditional definition of a bear market is a 20% or greater decline in stock prices.
Some corrections are sharp, but brief, lasting only a day or two — such as the Dow’s 500-point drop in October 1987 — or for a few weeks. Sometimes a short, dramatic decline serves as a prelude to a lengthier downturn. The 1929 crash and subsequent three-year bear market,
which saw the Dow lose almost 90% of its value, illustrates this latter possibility.
In the 1930s, the Cowles Commission, formed to guide investors through the aftermath of the 1929 crash, came up with five essential rules for successful investing, which are still applicable today:
Invest for the long term. While the stock market can be risky over the short term, risk decreases as your investment time horizon lengthens. A good rule of thumb is that stock and bond investments should be funded with money you won’t need for at least five years.
Invest systematically. One way to avoid the timing dilemma is to use a simple strategy called dollar-cost averaging — the practice of investing a fixed amount of money in a particular investment at regular intervals. Because the amount invested remains constant, the investor buys more shares when the price is low and fewer shares when the price is high. This means that the average cost per share tends to be lower than the average market value of the investment over the same period.
Dollar-cost averaging cannot eliminate the risks of investing, guarantee a profit or protect against a loss in declining markets. The success of the program depends on making regular purchases through advancing and declining market periods — and on selling when your investment is worth more than the average price you paid. Since such a plan involves continuous investment in securities, investors should consider their financial ability to continue purchases through periods of low price levels.
Diversify investments. When people think about investing their money, they probably envision themselves comparing the merits of various investments. But before they get to that step, there is a more basic decision to make: asset allocation. Asset allocation is the percentage of investment funds an investor allocates among asset classes such as stocks, fixed income, cash equivalents, and tangibles/real estate.
The decision is an important one. A study of large pension funds determined that a pension manager’s allocations among asset classes had a far greater long-term effect on returns than the individual securities selected.
Buy quality. Periodically, investors become enamored with initial public offerings (IPOs). By definition, however, IPOs involve companies whose stocks are untested in public trading. The average investor should approach this arena with extreme caution and commit no more than a small percentage of investment capital to it.
At the other end of the spectrum are the many companies with histories of consistent sales and earnings growth. Although nothing is guaranteed in the investment markets, there is a lower probability that such companies will drop off the investment map during a correction. Rather, a correction presents investors with the opportunity to acquire more shares of historically seasoned, financially sound companies at reasonable prices.
Get professional advice. Each investor brings a different outlook and level of sophistication to the markets. Most investors can benefit from some degree of professional input. Whether that means professional research on individual securities, advice on asset allocation, or entrusting money to professional portfolio managers, investment professionals are great resources for helping investors achieve their financial goals.
Particularly during corrections, it helps to have a coherent investment strategy worked out in advance and to be able to keep that strategy clearly in mind as events unfold. A qualified investment professional can help plan a sound investment strategy.
(Gary P. Brinson, Brian D. Singer, and Gilbert L. Beebower, “Determinants of Portfolio Performance II: An Update,” Financial Analysts Journal, May/June 1991.)
This article was written by Wells Fargo Advisors and provided courtesy of Robert Bridgers, Financial Consultant. 843-524-1114.
Investments in securities and insurance products are: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE.
Wells Fargo Advisors, LLC, Member SIPC, is a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Company.