Panic is not an investment strategy

Doug Horn

At the time I am writing this article the market recently closed down 512.76 points, or 4.3 percent with the upcoming jobs report, being the next indicator of how the market may move. Clearly, the decline was not reassuring and perhaps déjà vu of fall 2008 when the Dow Jones Industrial 30 declined 3,991.26 points or 34.5 percent over two and a half months. No crystal ball can predict the direction of the market in the days following this most recent move. Whether the recovery will continue and this selloff will ultimately recover, or the economy will slip back into a recession which is what this selloff may be anticipating is hard to predict.

The move thus far is equivalent to a correction, which is defined as a ten percent retracement from the recent high. From April 29 through Aug. 4, the DJ 30 has dropped 11.14 percent. While the amount of the decline meets the definition, the way in which this correction occurred is anything but typical. Corrections are not infrequent, and occurred as recently as last year.

In 2010 the market declined 13.55 percent from April 23 to July 2. This moved wiped out the gains year-to-date and actually took the market into negative territory. However, the market once again started up and by year end, the DJ 30 had moved up 19.52 percent from July 2 or up 11.02 percent for the calendar year. No one knows whether 2011 will repeat the performance of 2010, or if this is the start of more volatility and perhaps more down days.

Getting scared and responding with emotion is rarely the best course of action. Once again, the investment time horizon must be confirmed. If the objectives are long term, such as needing income from now until the end of retirement or for the start of retirement which is years into the future, market corrections often create opportunities which should not be missed.

During volatile times like this, investors often asked how to control their risk. We have been taught mutual funds are the answer. Due to their diversification and professional management many investors elect to invest exclusively in mutual funds. Another option is to invest in individual securities, but this is often referred to as having greater risk than mutual funds. This is true if someone invested in five mutual funds, and another investor invested in five individual stocks. Clearly the stock portfolio should experience greater volatility. But, what if a third investor purchased four mutual funds and then created their own fund by investing in 25 to 40 individual stocks.

In my opinion, adding select individual stocks may not raise the risk significantly when the concentration in each holding is limited to one to three percent of the portfolio. Using hind sight, there are a large number of stocks that while their value dropped during the last recession, and some significantly, their value recovered more quickly than the market as a whole. Two examples are Caterpillar (CAT) and The Southern Company (SO). This is not a recommendation to purchase these companies today, but is an example of how they responded to the market during the last four years.

The S&P 500 reached its peak value Oct. 9, 2007, and is still 23 percent below its October high as of the Aug. 4. For CAT, the value as of the fourth is 8 ½ percent higher than its Oct. 9 value. Even though the stock dropped to a value around $23 per share during what could be described as panic selling in early 2009, all of CAT’s value has recovered even though the S&P 500 is still significantly below its prior high. The same story can be told of SO. It is currently 5.6 percent above its Oct. 9, 2007 value and is currently yielding approximately 4.8 percent with its quarterly dividend payment.

During the 500 point selloff last week, there were many mutual funds with percentage losses greater than the market’s move that day. This is sometimes caused by the influx of redemption requests forcing the manager to raise cash to meet the requests. While mutual funds offer diversification, they do not offer much transparency since it is rare the fund shareholders ever know what the fund actually holds until months after the fact. Holding individual securities may not be for everyone, but it is something to consider.

For assistance with portfolio allocations, insurance, estate planning, or investment management contact me at Quality Financial Concepts or one of the other Certified Financial Planners in our area. To continue a personal quest for education, you can also view our learning center on our website, www.goqfc.com. There you will find articles on a variety of topics, on-line seminars, calculators, as well as a host of other free tools.

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