During his May 22nd testimony on Capitol Hill, Fed Chairman Ben Bernanke dropped a bombshell when he said that the Fed could pull back on its bond buying “in the next few [FOMC] meetings,” depending on prevailing economic data. Many investors interpreted the comment as a hint that the Fed’s stimulus was coming to an end. Remember that the Fed keeping interest rates low has spurred many investors into stocks, because they seemed preferable to cash, bonds or commodities. If rates start to rise, that decision may change. Guess what? Things are changing!
In the US, stocks are only down about 2 percent from the intraday high on May 22nd (now dubbed "B-Day" for Bernanke), but other markets are down more dramatically: bonds plunged about 7 percent; emerging market stocks have tumbled 10 percent; emerging market currencies are off sharply; and Japanese stocks have sunk 15 percent from recent highs.
With markets on a seemingly-unending daily roller coaster ride, here’s what you should do: NOTHING. This prescriptive measure is geared towards investors who have been sticking to their game plans and rebalancing ever quarter or so. If you are in that category, please sit still and don’t do anything.
But if you have been flying by the seat of your pants, use this market volatility as an opportunity to review where you stand, create a target allocation and force yourself to rebalance according to your goals.
Here are 6 more tips for every investor:
- Dont let your emotions rule your financial choices. There are two emotions that tend to overly influence our financial lives: fear and greed. At market tops, greed kicks in and we tend to assume too much risk. Conversely, when the bottom falls out, fear takes over and makes us want to sell everything and hide under the bed.
- Maintain a diversified portfolio. One of the best ways to prevent the emotional swings that every investor faces is to create and adhere to a diversified portfolio that spreads out your risk across different asset classes, such as stocks, bonds, cash and commodities. (Owning 5 different stock funds does not qualify as a diversified portfolio!)
- Avoid timing the market. Repeat after me: “Nobody can time the market. Nobody can time the market.” One of the big challenges of market timing is that requires you to make not one, but two lucky decisions: when to sell and when to buy back in.
- Stop paying more fees than necessary. Why do investors consistently put themselves at a disadvantage by purchasing investments that carry hefty fees? Those who stick to no-commission index mutual funds start each year with a 1-2 percent advantage over those who invest in actively managed funds that carry a sales charge.
- Limit big risks. If you are going to make a risky investment, such as purchasing a large position in a single stock or making an investment in a tiny company, only allocate the amount of money you are willing to lose, that is, an amount that will not really affect your financial life over the long term. Yes, there are people who invest in the next Google, but just in case things don't work out, limit your exposure to a reasonable percentage (single digits!) of your net worth.
- Ask for help. There are plenty of people who can manage their own financial lives, but there are also many cases where hiring a pro makes sense. Make sure that you know what services you are paying for and how your advisor is compensated. It’s best to hire a fee-only or fee-based advisor who adheres to the fiduciary standard, meaning he is required to act in your best interest. To find a fee-only advisor near you, go to NAPFA.org.