Navigating bumps along The Street
Back in the day, a 200-point move in the Dow really meant something. Now it's just the typical morning routine; and after lunch, there's often an equally large swing in the opposite direction.
If The Street used to feel like a well-paved avenue, these days it's more like a pothole-riddled mountain road. Investors need new techniques to stay on the right path and ensure a smooth ride.
The increased volatility comes from many sources: cheap and easy online trading for individual investors, programmed trading by institutions, a raft of risk, and jitters all around.
Those jitters are measured by a bit of math called the Exchange Volatility Index from the Chicago Board of Options. There, folks trade options on the future of the index, which is itself a blend of prices of options on stocks in the Standard & Poor's 500 stock index. It's said to measure investor fear and predict market volatility. What it's saying now is: Expect more wild rides ahead.
That means the conventional investment technique that used to work best -- buy gradually and hold indefinitely -- doesn't seem to make as much sense. There's a psychological adjustment to be made, too. How can retirement savers concentrate on their daily lives while watching their portfolio rise and fall by thousands or tens of thousands of dollars every day?
Here's how to stay sane and make money in volatile times.
-- Know yourself. Write down your own financial policy statement. Include points like how much you can stand to lose before you can't sleep at night and the time horizon for your investments. If the recent 200-plus losses are causing you serious stress, back off. Hire a fee-only adviser to manage your money, or move more of it into safe bank certificates of deposit. If you're investing for a future that is at least 10 years away, train yourself to worry less. Then you can think of every free-fall as a buying opportunity for the future.
-- Take your short-term money off the table. If you're going to need it within five years, put it in a bank account, a money market fund, or Treasury bond with a maturity that matches your schedule for wanting access to the money.
-- Use techniques that minimize risk. One is called value averaging. This is a way of moving money into a diversified mutual fund gradually, and it helps you make the most of a wild market. It works like this: Set a guideline for how much you'd like your total investment to grow every month. You might decide you want to have $200 more in your account at the end of every month. If, at the end of the first month, the share price has gone up so much that you now have $150 extra in the account, you only have to add $50. If, instead, the price has dropped and your holdings are $150 in the hole, you'd have to add $350. Over time, this forces you to put more money in when prices are weak and less money when prices are high. It's buy low, sell high on autopilot.
-- Sell more aggressively. Take tax losses whenever you find them, like now. By the end of the year you may have gains you'd like to offset with losses you are building up in the first part of the year. Just remember not to buy back the same securities within 30 days, or you'll jeopardize the tax break. Sell more aggressively to protect yourself during routs, too: You can set stop-loss orders with your broker that automatically sell you out of a stock that's dropped by, say, 10 percent. That would protect you if a stock you owned (Citicorp or Countrywide, anyone?) went into free-fall.
-- Buy more aggressively. Recessions and bear markets don't last forever. Solid companies get taken down with the problems when the whole market sells off. Keep a shopping list of solid-company stocks you'd like to own five years down the road, and buy them when they're getting beaten down.
-- Rate your financial service providers. Is your online broker always responsive immediately when you're ready to make a trade? What about the broker/adviser you're paying? If you're having trouble getting through on difficult days, find another provider. And keep those fees to a minimum, by keeping the bulk of your portfolio in low-fee index funds or exchange-traded funds. When gains evaporate overnight and yields are negligible, you can't afford to pay 2 percent or more, just to be in those investments.
-- Diversify, diversify, diversify. If some of your money is invested in real estate, foreign stocks, commodities, bonds and in different kinds of stocks, you'll bleed less than the investor who has it all riding on the SP500.
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