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The following post is by MPFJ staff writer, Greg Johnson. Greg is a proud husband, father, and debt crusader who is in the process of becoming debt free. Along with his wife, Greg co-founded the personal finance blog, Club Thrifty, where they encourage readers to "Stop Spending. Start Living."
Unless you've been living under a rock, you have probably heard the news that the markets have been on a pretty sweet rally recently. At the time this was written, the Dow Jones Industrial Average was over 15,300, and the S&P 500 sat at almost 1,670 – both record highs.
Stock market rallies like these can make your financial year in only 6 months. Better yet, they build our confidence as investors. Heck, everybody feels like they are the next Warren Buffet when the market is going gangbusters. Yet, the smart investors realize that the market works in cycles.
Unfortunately, honeymoons don't last forever. Whenever there is an extended period of rampant growth and excitement, there is almost always a little trouble lurking right around the corner. Being prepared for the downturn can help you from giving back your gains and losing your sanity.
Here are a few tips to help you ride out the next short-term market storm.
1) Invest for the Long-Term
Long-term investing is one way to help stave off the fear of down markets.
When you are investing, time is almost always your best asset. Why? Because time allows you to wait out the short-term fluctuations of the market. Even with the abysmal performance of the stock market over the previous 5-10 years, the stock market's average annual rate of return over its history is still near 10%. Since we can not guarantee future performance, the best way to predict it is to look at past performance. Thus, if you invest over the long-term, past performance would indicate that it is likely that you will receive a near 10% return on your investment.
Investing with a short-term mindset makes you much more vulnerable to the short-term swings of the market. So, when it comes to purchasing a security, make a decision and stick with it. Fight your fear, and ride out the wave of discontent. While the belief that high markets will eventually come down usually is correct, remember that the inverse (markets that are down will usually go up) is also typical.
2) Don't Try to Time the Market
This goes hand in hand with investing for the long-term. You've heard the saying, "Buy low, sell high?" In my opinion, trying to time the swings of the market will only get you into trouble. Guessing what the markets are going to do will only cause you headaches and cost you money.
Essentially, trying to time the market is gambling. Luck plays a major part in the success of somebody with this investing mindset. What most of us should be doing is trying to eliminate luck from the equation as much as we possibly can. Unless you are a very experienced day trader, the fact is that you should probably be investing your money for the long-term. The "everyman" would be wise to only purchase securities that he plans to hold onto for at least 5 years, preferably 10. If you assume that attitude, you are bound to make money in the good times and ride out the valleys that the market will eventually throw at you.
3) Stick to Your Plan and Don't Panic
When the stock market is riding the tidal wave up, it is easy to get excited and want to invest all you have in stocks. Of course, the opposite is true as the wave crests and the market begins to come crashing downward. Terror can easily set in as you realize all of the gains you worked so hard for are slowly, or quickly, washing away. However, sticking to your plan in both the good times and the bad can help you to avoid those gut wrenching feelings of sheer panic.
By creating and maintaining a set asset allocation, you can rest easy knowing that your overall financial plan is suited to help you make money in the good times and minimize losses during the bad. Furthermore, keeping to a relatively strict asset allocation plan will help you to diversify your wealth so that you are not too heavily invested in only one type of investment - like stocks or real estate. You should meet with a financial professional to help you determine your specific plan based on your investment horizon (the length of time you plan on investing) and your personal risk tolerance. Once you have your plan, stick with it. Keeping with a well thought out program will protect you from getting greedy during the upturns and self-defeatist during the rough times.
How about you all? What are your tips for staying sane through the ups and downs of the market? How do you protect your assets from market fluctuations?
Share your experiences by commenting below!
***Photo courtesy of http://commons.wikimedia.org/wiki/File:MICEX_Index_graph.png
