Portfolio tips to help smooth out the market

By AARON KATSMAN
December 28, 2011 22:26

Your Investments: The worst thing you can do as an investor is panic, sell everything, and wait for a market recovery.

3 minute read.



Wall Street

Wall Street_311. (photo credit: Thinkstock/Imagebank)

If you are an investor, the best investment you could have made this year was to buy a few bottles of Rolaids. With all the stomach-churning volatility that has symbolized the stock market for 2011, the only relief has been some antacid.

All joking aside, to say that 2011 has been a tough year for investors is an understatement. Outside of the US, most markets are down double digits for the year. It’s not just losing a bit of money that has investors feeling jilted; rather, it’s been the way that markets have behaved, which has chased many well-meaning investors from the stock market.

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Violent, day-to-day market movements have left investors wondering if there is any way to try and smooth out the ride.

This volatility is precisely why investors in the stock market need a long-term horizon to be able to withstand all of the market ups and downs. Here are three investing tips that may help investors remain sane during market swings:

DIVERSIFY
Diversification is an investment technique that uses many varied investments within a single portfolio. The idea behind it is that a portfolio of different kinds of investments may, on average, yield higher returns and pose a lower risk than a single investment. Diversification tries to smooth out volatility in a portfolio caused by market, interest-rate, currency and geopolitical risks.

In layman’s terms, don’t put all your eggs in one basket. But it’s important to remember that diversification does not assure against a loss.

If you include bonds in your stock portfolio, it may take away some of the volatility of the portfolio, allowing for potentially more stable returns over the long run.

DON’T PANIC
Keep your eyes glued to your long-term goals. It’s important to remember that markets go up and down, and if you made a financial plan, it would have taken this type of market volatility into account.

The worst thing you can do as an investor is panic and sell everything and then wait for the market to recover. The market tends to recover very quickly. Large market gains often come about in quick and unpredictable spurts, and missing just a few days of strong market returns can substantially erode long-term performance.

Remember the famous investing principle of buying low and selling high. Investors who panic often end up selling low.

REBALANCE
The third principle is for investors to update or rebalance their investment portfolios. Rebalancing is necessary for two main reasons. First of all, it keeps your asset allocation in line with your risk level. Secondly, it keeps your portfolio in line with both your short- and long-term goals and needs.

For example, when you first decide to invest, you decide that an allocation of 70 percent stocks and 30% bonds seems right for your $100,000 portfolio. We can also assume that over the last decade, the stock market treaded water and didn’t budge, while bonds surged.

Based on the assumption that all gains and dividends were reinvested, and you didn’t deposit or withdraw any money, you would find that the stock portion of the portfolio would be worth more or less the initial $70,000. On the other hand, your bond holdings would be worth a lot more than the $30,000 invested in them.

However, while it’s true that over the last few years your portfolio in this case would have grown, it would have also become more conservative. The reason for this is because the portfolio would move from being a 70% stock and 30% bond allocation to an allocation of 60% stocks and 40% bonds.

In this situation, if you don’t rebalance and you have a more conservative portfolio than you need, and if the market starts to recover, you won’t be participating to your fullest potential.

It’s a good idea to implement these three tips because they are a possible means to help you weather the storm of volatile markets.

Past performance is not a reliable indicator of future results. The S&P 500 Index measures large-cap stocks and US stock-market performance of leading companies in leading industries. An investor cannot invest directly in an index.

aaron@lighthousecapital.co.il

Aaron Katsman is a licensed financial adviser in Israel and the United States who helps people with US investment accounts.


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