Some investors have been hit harder than others. Certainly those investors with a large percentage of their assets in the stock market have seen a greater decline in value than those with less invested in the market.
Fortunately there are some things the average investor should know that will help mitigate losses during the next downturn and enhance returns during the next boom in the stock market. For example:
- Do not fool yourself into thinking that you are diversified if you own five different bank stocks or three different large cap growth funds. Diversification works when the investments chosen to make up your portfolio are very different from one another. A portfolio consisting of large cap, small cap, growth, value, and international investments is a better diversifier than owning all bank stocks or all large cap growth stocks. Even better would be one that includes bond investments in addition to stock investments and maybe even a little cash.
- Do not try to time the market. Everyone seems to agree that trying to time the market is hard to do, but many continue to try. Put simply, market timing is the practice of buying when you think the market has hit a bottom and selling when you think the market has reached a high and is about to fall. The problem is that markets do not go straight up or down. There can be big moves up or down even as the market trends up or down. From August 28, 2008 through April 17, 2009, for example, the S&P500 was down a total of 33%. At one point during that time frame, the S&P500 had dropped as much as 49%. However, twice during that same time frame the S&P500 rose by more than 24%. Market timing involves making two correct decisions; that is buying at the right time and selling at the right time. Swings in the market as described above make it virtually impossible to get both the buying and selling timed right.
- Do not hold onto an investment solely because at one time the price of the investment was much higher than it currently is. It is no secret that most people are too emotional when it comes to dealing with their money and investments. Just because you owned Citigroup at $55 a share does not mean that it will eventually sell for $55 a share again. It may, but then the Washington Nationals may also win the National league pennant. Holding on to the stock just in the hope of it going back to where it once was is no different than a gambler doubling down on his losses in order to get back to even again.
- Do not hold onto an investment that has done very well simply because you do not want to pay income taxes on the sale. Last time I checked, the tax on the sale of an investment was never more than the proceeds received in the sale. Furthermore, for investments held for more than a year, the tax is even less and in certain circumstances zero. If the investment is no longer appropriate for your portfolio or as a percentage of your portfolio exceeds 10%, then by all means sell the investment, pay your taxes and reinvest the proceeds in a more appropriate investment.
- Do not invest money in the stock market that you may need within the next five years. People saving for their teenage child’s college education or to buy a house within the next few years should invest all that money in low risk types of investments such as bonds or cash. The risk of principle fluctuation is just too great to take a chance with the money.
Following the above suggestions won’t assure that in the next downturn your investments won’t lose money. They will, however, go a long way towards helping you understand what needs to be done to avoid making those major mistakes that can result in permanent losses and major damage to your portfolio.
About the Author:
Howard Hook is a CPA and Certified Financial Planner with the money management firm of Access Wealth Planning in Roseland and Princeton. Howard received his Bachelors Degree in Accounting from the State University of New York at Binghamton in 1987. Before joining Access Wealth Planning LLC, he was a senior manager at a prestigious accounting firm servicing clients in New York and New Jersey. In 1997, Howard received his CERTIFIED FINANCIAL PLANNERTM (CFP) designation from the College for Financial Planning in Denver, Colorado. He is a member of the American Institute of Certified Public Accountants (AICPA) and the Financial Planning Association (FPA). He specializes in tax planning for individuals and small businesses. For more information, please visit www.awplan.com; e-mail: email@example.com or call (973) 740-2400.