Special to The Daily Record//June 17, 2012
//Special to The Daily Record
//June 17, 2012
After more than a 10 percent move to the downside, accounting for the worst monthly performance in more than a year, the stock market as measured by the S&P 500 is officially correcting, but it is certainly not collapsing.
By late March and early April of this year, many of the same indicators that foreshadowed similar corrections in prior years warned of the high likelihood of a “Spring Slide,” in which we are now firmly entrenched.
What becomes paramount for investors is how they act during the correction, as decisions made now may have a big impact on how their portfolios perform through the end of the year.
First and foremost, controlling emotions is imperative.
Even a correction that wipes out the year’s gain, as this one has done for the Dow Jones Industrial Average as of June 1, is not novel. In fact, it is quite common for the equity markets to experience intra-year moves of 10 percent or more.
Thus, letting fear dictate investment decisions may lead one to sell close to a market bottom, anxious that further losses are imminent. While the total scope of any market trend is not evident until a new one begins, the odds of timing correctly each top or bottom exactly are almost nil. When you base the investment decision on emotion alone, the odds are even less favorable.
In lieu of letting emotions take hold, investors who have not made significant changes to their portfolios before or during the correction may be best served by letting the market run its natural course. There are risks associated with relying on asset allocation alone, as the strategy does not guarantee against losses, but if a portfolio was appropriately allocated heading into the downturn, then diversification among different asset classes can provide some relief during periods of heightened volatility.
Rebalancing a key component
A key component of a good asset allocation strategy is rebalancing, which takes on even greater importance coming out of a market correction. Since all asset classes do not move together, certain groups may lead the charge lower, while others lead the recovery.
Reallocating a portfolio after drastic short-term movements may be necessary to bring the allocation back in line with a base model or similar starting point, which should be based on the investor’s investment objective.
If an investor did make significant changes to his allocation before the correction, then his decisions now become a bit trickier. An investor who over-weighted equities before the drop and can afford to take the associated risk may want to wait out the correction.
Conversely, an investor who pulled equity money from his portfolio and now has a higher percentage of cash in his accounts may want to start looking for attractive entry points for those assets.
Obviously, no one can pinpoint the exact bottom in the equity markets, but a 10 percent decline often creates attractive valuations when accompanied by oversold markets. The decision to commit funds for investing should be done within the framework of a dedicated strategy and reinvested into holdings that rebalance the portfolio to an appropriately risk-adjusted allocation.
Finally, investors should be hesitant to believe that this time is any different from what they have seen before.
For the markets, as for many things in life, uncertainty is a constant. When it comes to investing, success is often measured by how an investor manages the uncertainties. Yes, the issues facing today’s markets may be scary, but the one thing they are definitely not is new.
Problems in six decades
Domestic fiscal problems, to some extent, have been found in each of the past six decades. An international crisis that threatens to upset world economies, place possibly extreme burdens on commodities and currencies and is ripe with contagion fears? Well, the “Asian Flu” crisis of 1997 comes to mind and gripped many of the same headlines not even 20 years ago.
If uncertainty is one of the few constants in investing, then investors need to realize that the issues facing the markets today will give way to new uncertainties tomorrow. The historically upward trend in the S&P 500 has happened partly because of, if not in spite of, many similar events that have shaped our history.
Ignoring the long-term success of the financial markets, letting emotions dictate decisions and believing that this time is different from all of the rest will put some investors at a disadvantage. Other investors will be able to take advantage of this recent market correction by rebalancing their portfolios near market lows or even just staying the course.
Kevin Fusco is senior vice president of Fusco Financial Associates Inc. of Towson. He can be reached at 410-296-5400, extension 109, or [email protected]