If you believe many of the headlines and have been unnerved by your June statements which showed a drop in the value of your nest egg, you are not alone. The action you take, though, may be the difference between a mediocre return and an acceptable return.
Two common mistakes occur when you make investment decisions driven by fear - either your own fear or that of the media-driven public. You sell at or near the bottom of the market, ignoring the most basic of all investment wisdom: "Buy low and sell high." The other behavior dictated by insecurity is to stay out of the market too long, which insures you will never have the chance to "sell high."
During this and any bear market, one or more rallies may occur prior to the market reversing direction and starting a more extended bull market. These short term rallies generally will not reach prior market highs before brisk trading volume loses its steam and the market once again tests earlier lows.
For mutual fund investors, trying to take advantage of these trading rallies is not the best idea, in my opinion. Purchasing a mutual fund for a short term rally generally does not work due to the fund's diversification. Most funds hold between 80 and 400 investments, and unless the fund is industry specific, its own diversification may limit its upside potential during short-term or brief rallies. Managing the allocation among all of your holdings, and doing so approximately every six to nine months, may provide more desirable long-term results. This practice should permit you to become more conservative when the markets start to turn bearish, thus limiting declines, then gradually reinvest when others are running for cover.
Having the courage to purchase investments in the face of fear requires insight, information, and staying power. You must have sufficient funds set aside to meet current needs, so you can hold existing positions and even make additional purchases when dips occur. This will allow you to average downward the purchase cost and reach desirable profit levels at lower price points. For example, let's say you purchase 100 shares of a $30 stock that in the past traded higher. The share price drops further, and you add 150 additional shares at $20. Your total investment is now $6,000 in 250 shares, an average purchase price of $24 per share. Should the stock value recover to $35, you could realize a 45% gain on the total investment. Had the second purchase not been made, the potential gain would have been only 16%. But beware - buying the additional shares because you 'know' the stock will recover is another mistake; not all stocks that decline will recover, and buying more shares without specific knowledge and reasoning can spell disaster.
So, we return to our original question - is now the time to buy? Bear markets always provide opportunities to purchase new holdings at very reasonable prices. Provided you have the ability to stay with the investment until the next bull market, which may be months and sometimes years away, then many of your purchases may provide higher than average returns. But, is this something the average investor should try? Generally, the average investor will make too many mistakes for this to be successful. They may concentrate too much of their money in one company, and that one holding may fail to recover. They may not have the financial means to wait for the recovery, before they must sell to create needed cash. They may purchase too soon and fail to make additional purchases when the stock dips in value due to a shortage of cash or a lack of confidence in their initial purchase. For the professional, yes it is time to be making selective purchases. For the novice, a properly allocated portfolio of funds may be the best vessel in which to ride out the storm.
The typical homeowner would not think twice about calling the A/C repairman or plumber in the event of a mechanical failure at the home. When faced with a repair bill of less than $500, most will call the professional to make the repair. However, when a portfolio is down 8, 10, 12 percent or more, many individuals will continue to try the do-it-yourself route despite the loss of thousands of dollars. While a professional advisor will rarely avoid all market losses, many will provide returns better than the general public's. For assistance with your portfolio, contact Quality Financial Concepts or other area advisors. And do it now, because every bear market of the past has been followed by a bull market, when well-positioned investors earned their reward for courage in the face of fear.
HOW TO REACH THE WRITER
Would you like a response to a financial question? Send your question to Doug Horn, 115 W. Broadway, Maryville, TN 37801. Be sure to mark your envelope Money Matters.
Doug Horn, CFP, is an area financial planner with more than 24 years financial experience and founder of Quality Financial Concepts, located in downtown Maryville on Broadway.
Doug Horn, CFP, Registered Investment Advisor in Tennessee and Texas and Registered Principal, Branch Office of and Securities offered through CUE Financial, Member FINRA, SIPC.