Stock Market Drop: Blip or Correction?

All of the sudden, those 30 percent stock market returns of 2013 seem like old news, as investors across the globe have a major case of the jitters. Worries about slowing growth in China, weakness in some US corporate earnings and the Fed's decision to curtail its bond-buying are all factors. But the biggest catalyst has been the unfolding drama in emerging markets, where local currencies have been battered. Countries that have depended on foreign investment – including Turkey, Argentina, Brazil, India, South Africa and Indonesia – are seeing a reversal of fortunes as local central banks finally take steps necessary to address  inflation and account imbalances. The fear now is that investors will pull money out of those countries, as well as other emerging markets, igniting a global sell-off in risk assets.

This latest round of selling has everyone talking about a  correction, or a drop of 10 percent or more from the peak. With yesterday’s sell-off, we are down about 4 percent from the recent peak, so we're not there yet. In fact, it's been nearly 28 months – back to the summer of 2011 – since the S&P 500 has experienced a correction. On average, the index has gone through a correction every 18 months or so since 1945.

Of course nobody knows whether the recent selling is a blip or a harbinger of scary things to come. That's why the best advice for diversified investors, who are adhering to a well thought-out game plan is to SIT STILL AND DO NOTHING. But if you have a bit too much risk in your portfolio, 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 that I periodically trot out during market gyrations:

1. 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.
2. 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!)
3. 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.
4. 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.
5. 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.
6. 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 and to find a broader number of advisors, use the Financial Planning Association's "Find a Planner" tool.