Friends Don’t Let Friends Bail Out of the Market

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!

Keep Investing

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.

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Filed Under: Investing

About the Author: Jeremy Vohwinkle is a Chartered Retirement Planning Counselor® and spent a few years working as a financial planner. Today, he helps people make the most of their money by writing about personal finance here and elsewhere on the web. Jeremy is also Coach at Adaptu and a regular contributor for other publications such as Intuit, and American Express. Be sure to follow Jeremy on Twitter or Google+.

20 comments
savings account
savings account

Excellent advice as usual. When I look at the present economic climate, I have to think” I'm still lucky yet"

cat
cat

Only chickenharted live the market at this point, the market can't be all the time on the bottom, anyway it'll go up, the tendetion always changes

Bruce Brammall
Bruce Brammall

Great site, guys. I'm a financial adviser in Australia and have, thankfully, not been having too many clients wanting to panic sell, even though our market has done even worse than most other major Western countries since November 1, 2007. We have been off about 45% at our worst. That's partly because we drove so much higher to start with, because we supply so much to China in the way of resources and we're being punished as China's growth slows.
It probably doesn't make a lot of news over in the US, but the Reserve Bank of Australia (equivalent of your Fed) has cut the official cash rate from 7.25 per cent to 5.25 per cent in three moves in September, October and November. They cut by 0.75% today, after a move of a full 1% last month, which shocked the hell out of the whole nation. No-one saw that one coming.
Even though our underlying economy is in great shape, there's plenty of fear and loathing about what's going to happen next year, as North America, Europe, the UK and Japan start to slide. We trade with the rest of the world and there's true fear happening.
There are big parts of our stockmarket that would appear to be screaming buys at the moment also. And I'm working with clients to get them to dip their toes. We're not having bank failures. We've got two of the biggest mining companies in the world (BHP and Rio Tinto) and I think we'll come out fine. A recession? Possibly. But it'll be shallower than most of our other western colleagues. Good to see the website.

Bruce "Debt Man" Brammall, www.debtman.com.au

Mike Rowan
Mike Rowan

Jeremy,

I always enjoy reading your posts....this one reminds me of when I was a financial advisor with UBS, and people wanted to dump everything right after 9-11. It would have been the worst possible thing to do in hindsight.

Also, we are organizing a financial blog community at www.erollover.com, and would love to get your permission to have a link to your site there, and also to extend you the offer of having a post on retirement on our front page, taking the place of the one from the Financial Woman. Check it out and let me know if you would like to contribute.

Thanks,

Mike Rowan

Jim
Jim

I don't quite subscribe to the theory that because the market is down we've reached a bottom, but that also doesn't mean we should all rush out an liquidate our holdings. I tend to like stocks right now that have 25% of their market value in cash and pay a hefty dividend. If you use this strategy to find both domestic and international names, you'd be earning an attractive yield to wait for a recovery and you'd also be hedging any currency risk to the dollar due to a runaway government on a spending binge of epic proportions! How longs can we go before the inflation gig is up?

Super Saver
Super Saver

Jeremey,

I think it's interesting that neither you nor the commenters show any sign of fear. Probably, means the market can go quite a bit lower.

I never thought the Dow would cross 8000 this year. While I am not pulling out funds, my plan is to wait until Dow 4000 or 12000 before adding new money:-) In the meantime, I'm hedging with options and plan to use inverse ETFs when the next rally happens.

doctor S
doctor S

Not only friends, but family members as well! My mom is in her late 50's and very late in to the retirement game as she works 2 different jobs. She got very scared and wanted to move her money out of what it was in but for her sake I told her to keep it where it was b/c she isnt planning on retiring within the next 5 years at least.

My friends on the other hand are another story, they are all giving me crap b/c their money is with my company (large financial service compnay focusing on mutual funds) and returns are bad. But they are bad everywhere unless you were in a hedge that bet against subprime. It will fix its self over time. Great post.

anon
anon

If you're a GenXer, you need to remember Bogle's quote: "This too shall pass." It's a calming quote and easy to remember.

The time to sell was when markets were overvalued, and P/E ratios were in the 20s. For now, be happy that you own equity in US companies, and I have faith in the US.

Nick
Nick

The one thing that those putting away money into their 401ks, etc., have to understand is that (like you alluded to), this is the equivalent of buying low and selling high. Sure the bottom might not have been hit yet, but you can't time the market.

stocks
stocks

One of the biggest advantages of being young in today's market, is that we don't have to respond to how the market is performing, because, hopefully our goal is that of long term, and recognized that the markets will go up again. But it does hurt seeing 40% loss in a month, just don't panic... step away from the broker...it will pass...

Savings account
Savings account

Great post Jeremy,it's easier said than done, being at both situations before;being advised by a friend and vice versa. Some months before the crunch I was told by a frd who is a financial expert to re-invest in a business X but I actually pulled out from it totally - Saved me a lot but on the other hand advised a frd to invest in crude oil and he made a kill.

Still early days though!!

LiveWellSimply
LiveWellSimply

Excellent advice as usual. When I look at the markets I have to think, "I'm glad I'm not 65..."

pays to live green
pays to live green

I agree that it was just plain stupid to get out of the market at this point. We are hitting a bottom and today we have rebounded a little and will probably rebound by next year.

FixThePig
FixThePig

It's amazing how many calls and questions I've got from friends and family about what to do during this crazy financial roller coaster. I think that we will still see some down turn in the world economy and if you're not willing to lose money during the bad times and make money during the good times, then the stock market probably isn't where you should be investing your money.

Tim
Tim

It's too late, by week's end all the scaredy cats will have left the market. the only other people left or institutional and hedgies, and we know the hedgies are shorting their way out of their mess, so we are looking for more downside. 7000 here we come.

Jeremy
Jeremy

Haha! Don't worry Anthony, there are plenty of sheep out there who only key in on the fear mongering in the media and will continue to flee the market and perpetuate the buy high and sell low mantra :)

Anthony
Anthony

Argh! You guys really make it more difficult and less profitable to be a contrarian when you're talking sense into your friends and family! Can't you just let them bump prices down another 5% so my upside can be that much bigger?

/sarcasm

Adam
Adam

If only my friends would listen. :) They are all going bat-sh*t. One of my friends pulled his money out of his bank and is keeping it in his apartment! I tried to talk reasonably about FDIC insurance but there is no listening to reason. Myself I'm appreciating the ability to buy stocks at discount rates for dollar cost averaging purposes.

MiningOilGasGuru
MiningOilGasGuru

ahah the mood is definitely key. If someone were to ask me for simple advice on a day like yesterday, I think I might have thrown a childish tantrum. What's with these democrats and republicans putting their JOB security in front of the nation's with yesterday's vote. Smells like the election where we wanted a revote in Florida.

“‘Wall Street’ broadly is being painted as the ‘villain’ that got the U.S. citizenry into the current mess – much like the ‘Pied Piper of Hamelin’ who led the children from their village like ‘lemmings over the cliff’.”

Source

jim
jim

Clever title Jeremy, unfortunately (or fortunately, I suppose it depends on my mood!) none of my friends ask me for advice. :)

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