With the Dow recording a record 777 point loss in one day, people are flocking to the phones to call their brokers or going online to make changes to their investments. In almost all cases, this is a very bad idea. If you’re reading this site, you’re probably not as concerned by the recent turn of events, but I bet you have some friends or family that are freaking out. Well, if you wouldn’t let your friends drive drunk, you shouldn’t let them make rash financial decisions that could have devastating effects.
We’ve heard all of the advice in the past few weeks: buy and hold for the long term, create a diversified portfolio, this is a buying opportunity, and everything else. This stuff is all great in theory, but when you see the actual impact a rough market can have on your money, it’s harder to stick with the plan. And for your friends who may not be up on all the latest personal finance information, they react even worse. So, do your friends a favor, and stop them from making a poor decision with their money.
Remember Your Investment Objective
If your concerned friends are anywhere in their 20s, 30s, or even 40s, chances are they are primarily investing for retirement and are in the accumulation phase of life. That means the main investment goal is to save as much as possible, and allow it to go to work and build up a nest egg that will be needed anywhere from around 15 to 30 or more years from now. Because of this time horizon, there is no doubt that there will be plenty of good years, and a number of bad years for investments. There is no way around that. Markets don’t go up indefinitely. So, coming to the realization that you might have to deal with a 20% loss one year to get 10% returns the next four years will help minimize the impact of recent events.
Creating a Diversified Portfolio
Even if they are investing for the long term, your friend may still be very unhappy with recent performance. If this is the case, then they are probably not invested appropriately for their risk tolerance or don’t have a adaquately diversified portfolio. Remember, the whole point of diversification is to minimize risk while maximizing returns. While you won’t eliminate risk completely, it should be manageable enough that you’re comfortable with it.
If your friend does have a fairly diversified portfolio but is still worried about the losses, then they are simply taking on too much risk. While conventional wisdom says that a 30 year old should be investing fairly aggressively in stocks, that doesn’t mean it’s right for everyone. Some people simply can’t tolerate seeing big losses, and that’s fine. But to shoehorn yourself into an investment mix that you’re not comfortable with just because someone says that’s what you should do isn’t a good idea either.
But the real key is whatever your risk tolerance and whatever your investment allocation should be, that is meant to work for you in both good times and bad. The whole point of creating a portfolio that reduces risk is to limit your losses on the downside, while capturing as many of the gains on the upside as possible. The problem most people have is they change their allocations based on how the market is doing, completely negating any benefits of the portfolio. Your friend won’t be successful if they try to time the market by switching portfolio types based on how the market is doing, so don’t let them do it!
If your friends are like many of mine, they somehow equate to investing in a declining market to throwing money away. I’ve heard people say that every paycheck they are throwing $100 away because their account is dropping by that amount. This is a dangerous way to view your investment account, and isn’t true at all. You have to remind them that they are buying assets, or things that actually have a value. And while the value does change from day to day, the money they deposit with each paycheck doesn’t just disappear. You’re still buying shares of funds that have value, and when things do begin to move back up, you’ll have more shares to capitalize on those gains.
Let’s not forget the impact of buying low and selling high. If you always invest more when the markets are doing well, and reduce or stop investing when markets are doing poorly, you’re doing just the opposite! You’re buying all of your shares at relatively high prices and you’ll seriously impact your overall performance. Wealth isn’t built by paying a high price for something. It’s built by finding value and selling at a high price, which can be done by investing in down markets. If I’d kill to get 20% off my next new car purchase (an asset that’s guaranteed to depreciate), why wouldn’t I want to do the same with my next investment in stocks (which historically appreciate over time)? Think about it.
Help Your Friends Out
The next time you’re approached by friends or family with concerns over the market or their investments, use these talking points to help them make a smart decision. They are probably overloaded with all of the information on the news, radio, and TV, and it’s easy for someone to lose sight of their goals and make a rash, and possibly very costly decision. If you really want to do them a favor, send them over here where they can subscribe to the site via email, and encourage them to check out pfblogs.org where they can find a stream of incredibly useful and timely articles.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.