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Investing: What You Can Be Doing Today

In my last blog, I discussed the latest market turmoil and how you should be approaching your investment strategy in the correct manner: From a long-term perspective. Short-term market myopia and not having your priorities in order only leads to the big mistake.

How can you turn this current market environment into your favor? These are the things that can work to your advantage:

-If you have excess cash to fund toward retirement plans, there is no time better to invest like today. As mentioned before, stocks are on sale now at discounts to what they were several months ago. So if you were planning to make your 2007 retirement plan contributions before April 15th, there is no time like the present to complete this. You may even want to fund your 2008 contribution as well if you have the extra cash and are certain you will be eligible to make a 2008 contribution. For those waiting on the sidelines for things to improve, don’t waste your time trying to time the market. Since most of the pronounced gains from a market recovery occur right after the bottom, by the time you decide that it’s OK to go back into the market, usually you end up missing more in the form of gains than the amount you saved by avoiding the market in the first place.

-If you are under a periodic investment plan, this allows you to continue to dollar cost average your investments at lower and lower prices, which will allow more stock to be bought with higher return potential. This is a tortoise and the hare analogy, which can be just as boring as watching paint dry, but cost averaging works nicely in a down market.

-Systematically rebalancing portfolio’s will re-coup losses by buying at discounted prices and amplify future returns. This strategy is simply selling high and buying low. So for example your targeted asset allocation is 60% stocks and 40% bonds; due to the markets, now it’s a 50/50 split. This is simply selling enough bonds and buying enough stock to return to this 60/40 allocation. For people in their working years, you can sell out of some of today’s out-performers and replace it with laggards or rebalance using new funds. For the retiree who needs cash flow, it can be simply selling bonds or safe assets now after years of culling stock off as it appreciated during the bull market.

-Tax Loss Harvesting: For those who have taxable accounts, the rise in the stock markets has created a situation where mutual funds have run up large gains over the last five years. In turn, many mutual funds issued large distributions last December, when reinvested this increases the cost basis of the stock. This coupled with the losses this month now have a lot of holdings trading at a tax loss. There is a way to turn lemons into lemonade. This is done by tax loss harvesting, which simply involves selling a holding at a loss and re-investing it in a similar, but not identical holding. As a result, this allows you to take a tax loss that you can use against your taxes or offset future gains and in turn, the portfolio allocation stays the same. I would however, check out IRS Publication 550 in regard to Wash Sale Rules to make sure you are correctly doing this.

In the end, the greatest risk isn’t what the markets do; it’s what you as the investor does. Acting on one’s emotion and selling at market lows is absolutely the best way to guarantee that you have lower returns and reduce your chances of achieving your financial goals along with that. Nobody likes to see the stock market go down, but if there was little risk of loss, then we wouldn’t earn superior long term returns that stocks have to offer as we wouldn’t be compensated as much for the lower risk.

Investing & Market Turmoil: How to Avoid the Big Mistake

With the global stock markets down roughly 10% across the board coupled with all the news about sub-prime, credit markets seizing, real estate meltdown and economic data leading us closer to recession, you can’t get away from the negative news. Sounds like a good time to sell and wait for things to settle – right?

Investors systematically do this over and over again; buy when the markets are at their top and sell at a bottom. And it’s the worst investing mistake that you can make.

In the December issue of Money Magazine, Jason Zweig’s article How to Lose $9 Trillion in a Bull Market discusses that the Wilshire 5000 Index was worth $1.2 trillion in 1982. The index has returned 13.3% annually. If an investor literally bought and held the market over this time period, the value of the market would have been worth $28.2 trillion today. But the value of the entire Wilshire 5000 as of September 30th 2007 was $18.7 trillion. Why the disparity? The individual investor is its own worst enemy; it’s simply because investors tend to pile in during rallies and panic and sell in the middle of capitulation.

How can you turn this market turmoil into your advantage rather than letting it run you? Here are some thoughts, perspectives and strategies to take as we experience this market turmoil:

• For the long term investor, short-term volatility should be viewed as meaningless noise. If you look back at history, current market conditions always encompass some element of worry and trepidation; this element of concern never goes away, just the story line root of the anxiety changes. In the long-run, short-term problems will fix themselves. It may not be overnight and you can’t time when this will happen, but they do get resolved. A lot of scary things have happened over the last fifty years, but somehow stocks markets have managed through this quite well.

• The investment strategy of the long-term investor should be dictated by their needs rather than current state of the stock market. When strategy is based on needs, you are acting upon achieving your goals; working with things that you can control (i.e. how much you save and your asset allocation). When you let the markets and performance dictate your action (i.e. timing the market, determining what asset is going to do better short-term), it’s perpetually putting you in a reactive position; working with things that you have little control over.

• The long-term investor should however, never put themselves in a position where they risk more than they can afford to lose. With a majority of bear market cycles lasting no more than three years. This means:

-For the person still in their working years, having an appropriate emergency fund that covers 3-6 months of monthly expenditures if you lose your job. In addition, any large cash needs expected in the next 1-3 years should be left in cash or safe assets like high quality bonds. Finally you need to be properly insured.

-The retiree should have at least three to five years worth of projected cash flow needs in “safe assets” such as cash or high quality bonds. Cash flow needs is defined as expected expenditures less pensions, Social Security and other reliable cash inflows. Again you need to be properly insured as well.

• Stocks are not a luxury for the long-term investor, they are a necessity. Few of us have sufficient enough assets to be able to hold a majority of their investible wealth in cash or low risk, fixed income assets. Stocks are the only investment that will allow you to maintain your standard of living twenty years down the road. You may not like the volatility of the market, but is it worse than lowering your standard of living during retirement? Worse, do you want to be dependant on others to take care of you?

• This downturn does not alter the long-term fundamentals of the stock market, it actually increases return potential. Think about it. When stocks go down, the projected returns on the market don’t stay the same as before. They go up because stocks are now selling at a discount to where they were before. If investors took the same view towards buying stocks when they are on sale just like a consumer product, many individual investors would have done a lot better over time.

Personally I don’t view this current market as a negative, I feel quite the opposite as these problems will resolve themselves and in the meantime, we can take advantage of this to turn this in our favor. In my next entry, I will discuss the tools at your disposal.