How to handle a volatile market

January 23, 2008 7:58:46 AM PST
Nydia Han talked to experts to find out about what to do in the current financial situation. In an emergency move to stimulate the economy, the Federal Reserve slashed two key interest rates by three-quarters of a percentage point Tuesday morning. One of the rates that got cut is the Federal Funds Rate, which ultimately impacts how much consumers pay on credit card debt, home equity lines of credit and auto loans.

Today, the Dow Jones Industrial Average ended down 128 points from yesterday. Vanguard activated what it calls its "Emergency Swiss Army Team" to take calls of concern.

The main message for experts here? Don't panic!

Ellen Rinaldi says don't make abrupt shifts in your asset allocation. But do ignore the market vane while the knee jerk reaction is to sell when the market's down, then you're locking in a loss for yourself.

Six Guidelines For Uncertain Times from Vanguard

1. Don't Panic. Market volatility tests the mettle of most investors. It is best to take in stride both precipitous declines and sharp advances. What's more, remember that any losses you incur are only "on paper" until you redeem your shares. Giving way to the emotions of the moment has a strong tendency to encourage you to buy when optimistic spirits create market highs, and to sell when pessimistic spirits create market lows - just the reverse of a common sense approach.

2. Don't Abandon Stocks And Bonds. On the surface, short-term market volatility makes a compelling case for completely abandoning stock and bond investments. Resist the temptation to do so. Over time, stocks have provided the highest returns and the greatest protection against inflation of the three primary asset classes, while long-term bonds typically offer relatively steady returns and a yield premium over cash reserves at the cost of some principal risk. Without doubt, vehicles such as bank deposit accounts and CDs certainly safeguard you against day-to-day price fluctuations, but do little to preserve the spending power of your assets over time.

3. Don't Make Abrupt Shifts In Your Asset Allocation. As a general rule, periods of adverse market conditions are poor times to take rash actions. Shifting your money from one asset class to another in the hopes of attaining short-term rewards or to avoid possible losses is rarely productive. In my more than 30 years in the investment management business, I have yet to come across a "market timing" approach that consistently works. In short, engage in such strategies at your peril.

4. Ignore the Market "Vane." The direction - up or down - of the securities markets should not dictate your investment strategy. Rely instead on your objectives, time horizon, risk tolerance, and personal financial circumstances for developing a sound investment program.

5. Gradually Implement Your Investment Decisions. Committing a large lump sum of money to stocks and bonds in a one-time investment - or liquidating these investments at a single moment - is akin to gambling. It is often better to invest gradually, making necessary changes in your allocation of assets to stock, bond, and money market funds over time. Put in more homespun terms, if your investment worries are keeping you awake at night, "sell to the sleeping point." We recommend that reaching this level be limited to a 15-percentage-point increment; i.e., if a 65-percent stock position is keeping you awake, reduce the allocation to no less than 50-percent.

6. Be Balanced. Maintaining a balanced portfolio of stocks, bonds, and cash reserves is a sensible way to moderate the various risks in the securities markets. Stocks make good sense for maximum long-term return and optimum protections against inflation; bonds, depending on their quality and maturity characteristics, offer varying degrees of income and principal stability; and cash reserves provide ready liquidity and the peace of mind of complete principal stability. Today's volatile conditions clearly amplify the merits of a well-diversified portfolio.

How close you are to retiring should affect what you do to a large extent. The closer you are, the more important it is you talk to a professional about backing off particularly risky stocks. Now we know consumers have a lot of questions about the economy and what they should be doing (if anything) in response.

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