Watch out for Wall Street’s curveball

During periods of economic uncertainty, financial markets are often characterized by wide swings in market value. Such volatility, with prices rising and falling, is a reflection of changing investor sentiment. It also reflects more substantive economic or political movements. By their very nature, financial markets rise and fall constantly, with an ever present potential for gain and loss.

So, how does one cope with constant market volatility?

Avoid an Emotional Response

When markets fall sharply, some investors will panic and sell all or part of their holdings, or shift assets into what are believed to be safer investments. Such emotion-based selling after a market decline simply turns paper losses into real ones and limits any possible gains if and when the market recovers. Some individuals respond emotionally and buy when the markets are “hot” and values are rising. The end result is often an investor who buys high, sells low and then wonders “What happened?”

Don’t try to “Time” the Market

Some investors attempt to time the markets by buying when the market is low and then selling when the market is high. The problem is that it’s never clear just when the market has reached a trough or a peak. In the classic Wall Street phrase, “No one rings a bell.” Market timing is a concept that, in theory at least, seems logical. In practice, however, no one has yet devised a system for consistently and accurately identifying market tops and bottoms.

Diversify Your Portfolio

Asset allocation is an investment strategy that seeks to reduce investment risk by spreading an investor’s portfolio over a number of different asset types. This approach takes advantage of the tendency of different asset types to move in different cycles, and thus smooth out the ups and downs of the entire portfolio. Stocks, bonds and cash, or cash equivalents, are the investments normally used. Tangible assets, such as real estate or gold, may also be included.

The asset allocation process normally begins with an analysis of the historical levels of risk and return for each asset type being considered. However, keep in mind that while historical data is useful as a general guide, there is no guarantee that past performance is a predictor of future investment performance. These historical values are then used as a guide to structuring a portfolio that matches the investor’s individual goals and overall risk tolerance level.

Regularly Review Your Investment Strategy

An investor’s portfolio allocation should reflect factors such as the investment goal, timeframe, need for liquidity, risk tolerance and income tax bracket. As time passes and as market economic conditions change, it is likely that an investor’s goals and the optimal portfolio mix to reach those goals will also change. Adjusting the asset allocation, known as rebalancing, is a regular part of good investment management in both an up and down market.

Take a long term view

Historically, the long term trend in equity markets has been upward, although there have been periods of decline. An investor can more easily ride out periodic economic storms by clearly understanding his or her long term investment goals and rebalancing the portfolio accordingly. Additionally, a portion of the portfolio can be placed in assets with more liquidity, which can then be used to meet immediate cash needs. The balance of the portfolio remains invested for the long term.

Automatic Investing

Rather than making a single, lump sum investment, some investors will invest an equal amount of dollars at regular intervals, also known as “dollar cost averaging.” This strategy does not guarantee a profit, nor does it protect against losses in a declining market. It does, however, have the advantage of buying more shares when the price is lower and fewer shares when the price is higher.

This information is for educational purposes and should not be considered specific financial, tax or legal advice. Always consult with a qualified advisor regarding your individual circumstances. Investment Advisory Services offered through Global Financial Private Capital, LLC, an SEC Registered Investment Adviser.

Brad Zucker, RFC® is the president of Safe Money Advisors, Inc., a Las Vegas-based independent financial advisory firm. He blogs on personal finance every Monday for the RJ. For more information visit www.SafeMoneyAdvisorsNV.com or connect with him via Facebook and LinkedIn.