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Two back-to-back, brutal days of stock selling, which wiped out more than $1.7 trillion in value from the S&P 500, has prompted me to dust off a post that I always have handy: an investor protection plan. This will not protect you against market downturns, those will happen from time to time. Rather, this is a step-by-step process to protect you against yourself, and more specifically, protect you against your desire to do something when you see lots of down arrows.
Step 1: Remind yourself why you are investing. Most of us are saving for a long-term goal, like retirement or college, which is likely years or decades in the future. Even if you were retiring within the next couple of years, your account needs to last another 20-30 years. That thought should help soothe some of the raw nerves, And here’s a bonus: as money comes out of your paycheck and goes into your 401 (k), 403 (b) or 529 plan, you’re purchasing shares at a hefty discount to the levels seen just a week ago.
Step 2: Be thankful for your diversified portfolio. As stocks tanked, bond prices soared (the yield on the benchmark 10-year Treasury note fell to an all time record low of 1.31 percent), which helped protect investors from the worst of the stock selling. Maintaining a diversified portfolio, which pegs the allocation between stocks, bonds, commodities, cash, and so on according to your time horizon (when you will need your money) and a realistic assessment of your financial goals and risk tolerance, is the winning strategy for most long-term investors. Don’t forget to rebalance your accounts (1-4 times a year) so that your allocation again reflects the level of risk on which you originally decided.
Step 3: Determine whether you need cash. Do you need to make a house down payment, purchase a car or pay a tuition bill within the next 12 months? If so, that money should never have been be at risk at all, so admit that you blew it and get whatever you need out of the stock or even the bond market and keep it in a safe savings, checking or money market.
Step 4: Check your risk tolerance. Sure, you felt bold when stock market indexes were making new highs. Maybe you even purchased a little more of your company stock, because “it’s really worth (fill in the blank)”. Now that those decisions are blowing up in your face, how do you feel? Maybe you really can’t stomach as much risk as you thought you could. If that’s the case, you may need to readjust your allocation. Here’s your warning: If you do make changes, do NOT jump back into those riskier holdings after markets stabilize. You need to make a pinky swear with yourself that you will stick to your revised plan, FOR REAL!
Step 5: Find free money. If you want to help yourself feel better about market losses, figure out how much you are paying in investment fees and determine if you can scoop up some free money. Can you replace an actively managed fund with a no-commission index mutual fund? How much are you paying a so-called advisor, who isn’t doing much to improve your bottom line? Could you replace him or her with an automatic investment platform at a fraction of the cost? Find that free money!
Step 6: Ask for help. There are plenty of people who can manage their own financial lives, but others can really be their own worst enemies and make classic market timing mistakes, which leads them to buy high and sell low. If you are hiring a pro, make sure that you know what services you are paying for; how your advisor is compensated; and be sure that he/she adheres to the fiduciary standard, meaning he/she is required to act in your best interest. To find a fiduciary advisor, go to NAPFA.org, LetsMakeAPlan.org, or AICPA.org.