Note from Louis Basenese: Last week, I told you about The Single Best Way to Respond to Market Volatility. Since I expect the volatility to spillover into this week, as well, let’s read how my mentor and colleague, Alexander Green of Investment U, says to handle this market. I suspect you’ll find his thoughts very worthwhile.
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You often read in the financial press that stock market investors should do this or short-term traders should do that. But which one are you and what should you be doing now?
Here are my quick and dirty definitions, followed by a few thoughts about how each ought to approach today’s wild and wooly financial markets.
- An investor is someone set on achieving long-term financial goals: a comfortable retirement, the kids’ college education, or perhaps the down payment for a new house. Success here is measured in years, so this week’s market action is largely irrelevant except as it offers unusual opportunities. The important things to consider here are quality, diversification, asset allocation and keeping annual expenses and taxes to a minimum.
- A trader is someone who is trying to beat the market in the short term either to goose returns or reach short-term financial goals. This approach is inherently more risky, as the market action over the last few weeks has made crystal clear. The key here is to own great companies that are likely to post positive surprises in the short term (for example, great sales, high earnings, new product announcements, or an unexpected takeover bid). A trailing stop is essential to protect profits and limit any losses.
For the long-term stock investor, the current selloff is almost certainly a gift from Fortune. I know, no one you know sees it that way, but look back through history. You’ll find that virtually every widespread market selloff was a buying opportunity.
Yes, the market can go lower in the short term. (That’s always the case, incidentally.) But over the last 40 years, the S&P 500 has seen 25 corrections of 10% during a bull market. In only nine of them did the losses grow to 20% or more. Despite all the naysayers, a further selloff is hardly assured.
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One of the Few Reliable Rules of Investing
Still, you should only nibble at great stocks right now, not throw money at them in wild abandon. (Although I’ll bet that’s not your instinct right now, anyway.) One of the few reliable rules of investing is that perceived risk and actual risk are inversely related: The more dangerous the market feels, the more likely it is to produce generous returns in the years ahead.
So long-term investors gradually shift some money out of assets like bonds that have appreciated sharply and move them into stocks that have depreciated sharply. The fact that this feels like the wrong thing to do is, paradoxically, just the confirmation you need. (You need only recall the market meltdown two and a half years ago to see what I mean.)
Short-term traders need to take a slightly different approach, however. If you’ve been using our recommended trailing stops, you almost certainly have been building cash the last few weeks as you protected profits and preserved capital.
Don’t be in any rush to put this cash back to work. To take advantage of a crisis, you don’t have to be the first one to the fire. Pick your spots and trade judiciously. (One good strategy is to buy the same stocks that corporate insiders are currently loading up on.)
Don’t Risk Missing a Significant Rebound
Despite the stormy weather, you should cast a few lines right now. It may be tempting to simply wait until things “settle down” but then you run the risk of missing a significant rebound.
In short, tune out all the end-of-the-world hysteria and think rationally.
- As a long-term investor, shift money in cash and bonds into stocks.
- As a short-term trader – and you may well be both – scoop up great companies selling at unusual discounts – there are plenty of them out there – and adjust your stops to protect your gains.
You’ll thank me when things get back to normal. As they always do eventually.