This article was originally posted on Blueprint for Prosperity.
A lot of inexperienced investors who invest in stocks either through mutual funds, index fund, ETFs or owning the stocks directly want great returns with minimal or no losses in the bad times. Unfortunately this isn’t possible for the simple reason that you can’t get great rewards in the equity game without taking great risks. Risk means that your investment could go either way. Your stock fund might get 10% this year or 30% or -30%. In 1929 the Dow lost 90% of it’s value – I’m sure that was a bit of a downer and not just for the guys stepping off window sills. Should you just buy GICs and not worry about the ups and downs of the markets? I would not recommend that because there is no guarantee that fixed income products will keep up to inflation.
Here are some of the things you can do to invest in the stock markets and get a good night’s sleep at the same time.
Own some fixed income – This could include bonds, gics, high interest savings accounts etc. When the market is crashing this part of your portfolio will hold steady and will reduce your decrease in portfolio value. How much you own is based on your tolerance for volatility.
Diversify – A lot of ex-Enron employees couldn’t sleep at night because their skyrocketing retirement accounts made them giddy – until the company went bankrupt and they were left with nothing. The idea behind diversification is to keep your many eggs in many baskets. If your investment in a buggy whip company isn’t doing so well then perhaps your automaker stocks will make up for it. If your telegraph stocks are dipping then maybe your phone company investments will make up for that.
You need to look at your investments and understand if you are diversified or not.
Things to diversity by are:
- Company – one rule is not to have more than 10% of your portfolio in one company, especially if you work for that company.
- Industry – owning 12 bank stocks is not diversified – The US market has a lot of different industries so buying a broad market index fund or ETF is very diversified.
- Country – although a good part of the S&P500 profits come from overseas – it doesn’t hurt to add some more foreign exposure.
- Currency – this kind of goes with the country diversification. While some people would prefer to purchase currency neutral foreign funds it’s not a bad idea to own different currencies.
Treat your portfolio like a portfolio – When looking at your gains or losses – do it for the whole portfolio and not each security. If you are properly diversified some of the investments will be doing better than others most of the time. If you own ten mutual funds and two of them are cratering but the other eight are doing well then you are probably doing ok.
History – Research the history of the stock market or read the following statement. Stock market goes up, stock market goes down – over the long run, stock market goes up. If you sell when it goes down and then buy on the way up then you are buying high and selling low – don’t do this. Another thing to be aware of is past bubbles – the more you know about them the more you can avoid them.
Keep track of your portfolio performance – If your portfolio goes up 15% per year for the last four years and then drops 20% this year – should you panic? No – you haven’t ‘lost’ anything and your best bet is to hang on.
Ignore the media – The media is not there for your education or to keep you informed. Their job is to sell newspapers, ads etc and that’s it. If the market falls 2% then it’s a “mini-crash”, if it goes up 2% then it’s a “strong day on Wall street”. I’ll leave you with a quote from Preet that I read on another blog which I like.
I remember someone saying that if you left the design of elevator buttons to the financial media, there would be no “Up” and “Down” buttons – they would read “SOAR!” and “PLUNGE!”.