Keeping a portfolio with a healthy mix of assets that are properly diversified may allow you to weather market shocks more easily.
How the Past Can Help Inform Your Investing Future
If you’ve been investing in the stock market for any length of time, you’ve probably endured a few stomach-churning market declines. And if you’re a newcomer, you’ve probably heard about the epic declines in the past.
Yes, it’s all true. But it’s also true that declines have been followed by advances. It’s important for you to know that past performance is no indicator of what could happen in the future. Stocks are risky investments and you can lose money. However, the past can be useful in providing context for investors.
“Investors shouldn’t look in the rear-view mirror,” said Joe Correnti, senior vice president of brokerage product for Scottrade. “But investors who understand what happened in the past might be better prepared to handle market volatility and hiccups in the future.”
Market Declines in Focus
S&P Capital IQ studied declines in the S&P 500 from 1945 through August of 2014, and one component of the results certainly can be viewed as nervously eye-opening. The market has fallen by at least 5% a total of 101 times, or more than once a year.
And 12 times, the market has fallen by at least 20%, which is the standard definition of a bear market.
But what happened after the declines? The S&P 500 bounced back. Market pullbacks of less than 10 percent usually lasted about a month, and within an average of two months, they recovered to their pre-reduction levels. Of course, the bigger the decline, the longer it took to recover. It took nearly 5 years for the markets to recover from the 3 times that the S&P 500 fell at least 40%.
The Market Timing Dilemma
The S&P Capital IQ numbers show the difficulty of trying to time the market. It’s impossible to know whether a market that’s fallen 5% might be primed for a recovery, or whether it might grind downward for two years and fall into “mega meltdown” status. So how should an investor react?
“Over the last 60 years, investors who have stuck with a disciplined approach to the market were more likely to have met or are on track to meet their goals,” Correnti explained. “But we don’t know what the market will do in the future. That’s why it makes sense to have a plan and stick to it. If not, you could end up buying when you should be selling, and selling when you should be buying.”
Investors who follow an asset allocation approach would have a certain percentage of their portfolio allocated to stocks, a certain percentage to bonds, and perhaps other funds allocated to other asset classes, including cash. If the market declines, investors would then rebalance their portfolios to their initial targeted allocation levels.
Rebalancing can act as a way to potentially buy low – when stocks are falling – and perhaps sell high, when stocks are rising.
“Rebalancing helps take the guesswork out of when to buy or sell,” Correnti said. “Your aim is to create asset allocation ratios that are right for your risk tolerance and your investment goals, and then try to maintain those ratios.”
You might not need to rebalance if you’re continuously investing funds. In that case, you simply contribute funds to the asset class that has fallen below your target.
“Most people don’t simply invest a lump sum and that’s all,” Correnti said. “They’re constantly putting money into their 401(k)s or IRAs. Those can be opportunities to get your portfolio back into balance.”
Financial Portfolio Perspective
Investors can’t predict the market, but they can prepare for whatever it might bring, Correnti concluded. “Without a plan in place, you’re more likely to make mistakes, whether the market is headed up or down.”
Question: What has been your investment strategy after market declines?
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Before you can achieve success in your financial portfolio, you should consider setting clearly defined investing goals.
Scottrade Brokerage President Peter deSilva was drawn to the firm by its client-first approach. This approach was demonstrated with the company named “Highest in Investor Satisfaction with Self-Directed Services” by J.D. Power.