Stock Market Correction 2015: 5 Investor To-Dos

The first stock market correction in nearly four years (in 2011, the S&P 500 sank by nearly 20 percent) has been a great reminder to investors of core concepts that can guide us through both good and bad times. First a note about this correction: it was long overdue. In statistics dating back to 1900 for the Dow Jones Industrial, here is the average frequency and duration for stock market sell offs:

• A decline of 5% or more has occurred about 3 times per year on average, and lasted on average about 46 days.
• A decline of 10% or more has occurred about once a year on average, and lasted on average about 115 days.
• A decline of 15% or more has occurred about once every 2 years on average, and lasted on average about 216 days.
• A decline of 20% or more has occurred about every 3.5 years on average, and lasted on average about 338 days.

Despite being a normal part of the investment cycle, these are trying times, which demand 5 simple investor action items. Here goes:

1. Keep Cool, Sit Still and Do Nothing! There are two emotions that 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. To guard against this cycle, try not to do anything amid these volatile trading sessions. Consider this: If you had sold all of your stocks during the first week of the financial crisis in September 2008, you would have been shielded from another 40+ percent in further losses (stocks bottomed out in March 2009). But how would you have known when to get back in? Most investors, from seasoned pros to mere mortals who are saving for retirement, lack the guts or lucky timing to buy when stock indexes seem like they are hurtling towards zero! As a result, even if you made a decent sale in the fall of 2008, you most likely would not have bought the rock bottom in March 2009 and you may have missed the near tripling in value of the indexes from the lows.

2. Remember: You are wired to fail. Human emotions can mess with your investment returns. Benjamin Graham, the founder of security analysis, said in his 1949 masterpiece, The Intelligent Investor. “The investor’s chief problem – and even his worst enemy – is likely to be himself.” Research proves the point: According to Dalbar’s 21st Quantitative Analysis Of Investor Behavior study, the 20-year annualized return (through 2014) for the average equity mutual fund investor was 5.19 percent, compared to the 20-year annualized S&P return of 9.85 percent. Investors lagged the index by a whopping 4.66 percent annually!

Dalbar says the biggest reason for underperformance is psychology, highlighted by investor panic selling at the bottom, as well as the lure of following short-term market trends. Guard against these big emotional pulls by reminding yourself that just because you feel something, does not mean you need to do anything!

3. Adhere to a diversified portfolio…and don’t forget to rebalance. One of the best ways to prevent emotional swings 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.

Prior to this sell off, the most frequent investment question I fielded on my radio show was “Should I dump my bonds?” I sure hope that you didn’t, because as the stock market has been sinking, those bonds were like a life vest to your portfolio. But that’s the rub with asset allocation: you have to live with certain parts of your portfolio underperforming at times, in order to reap the payback that occurs when market events turn the previous dogs into champions.

4. Maintain a healthy emergency reserve fund. Bad luck can occur at any time. One great lesson of the Great Recession was that those who had ample emergency reserve funds (6 to 12 months of expenses for those who were employed and 12 to 24 months for those who were retired) had many more choices than those who did not. While a large cash cushion seems like a waste to some (“it’s not earning anything!”), it allows people to refrain from selling assets at the wrong time and/or from invading retirement accounts.

5. Understand what is in your target date fund: Over the past ten years or so, many investors have been flocking to mutual funds in which the fund manager “targets” your future date of retirement an adjusts the asset allocation as you near the time that you will need to access the money. Unfortunately, many of these funds are far riskier than investors understand. Whether it’s a target date fund or an age-based investment for your kid’s college fund, be sure to check out the risk level before you put a dollar to work.

Oil Plunge and Janet’s “Considerable” Dilemma

Considerable adjective: large in size, amount, or quantity “Considerable” is the word of the week, as all eyes move from plunging oil markets to the Federal Reserve. This week, central bank officials gather for their last policy confab of the year. With bond buying now done and the economy expanding, the big question is: how might the Fed alter its policy statement to prepare investors for the inevitable increase in short-term interest rates?

Previously, the Fed has said that it would leave rates at near zero for a “considerable time,” but with the labor market improving and the economy gaining strength, there’s a case to be made to shift that language to a word of phrase that might equate to a shorter period of time. Analysts at Capital Economics have turned back the clock by a decade to see what terminology officials’ used ahead of the tightening cycle that began in 2004. “Back then the Fed went from saying that low rates would be maintained for a ‘considerable period’; to the FOMC would be ‘patient’ in removing accommodation; and then to accommodation will be removed at a ‘measured’ pace.”

Here’s how the Fed’s words translated into time:

• Considerable: 6 - 10 months
• Patient: 2 - 5 months
• Measured: one month

OK, so remember back in March when Fed Chair Janet Yellen had that woops moment at her first presser? That’s when she let it slip out that the Fed would raise rates “something on the order of around six months” after QE ended. Since QE concluded at the end of October, something on the order of six months would bring us to April 2015. Conveniently, there is a policy meeting on April 28-29, 2015 so that might be a fine time to start the process.

HOLD YOUR HORSES! The recent acceleration of the oil market sell-off may put a wrinkle on the “considerable” to “patient” exchange. While the 46 percent drop in crude oil from the June highs amounts to about $100 per month savings for US consumers, there are some analysts who believe that crashing oil is the canary in the coal mine for the global economy.

Until the last week or so, most have thought that the oil story was one part increased supply and one part tepid demand, but what if the balance is tipping in the wrong direction? In that case, falling oil has more to do with a big slow down in Chinese, European and Japanese economies than with the growth of U.S. production. In fact, that weakening growth prompted OPEC to predict that demand for its oil will hit a 12-year low next year.

If the world is really slowing down, then can the U.S. remain an outlier of growth for much longer? Investors answered that question with a “NO WAY” last week and sold stocks to underscore the point. After all, if you’re sitting atop healthy gains for the year (the S&P 500 is still up 8.3 percent YTD) and you think the globe is slowing, a reasonable response is to lighten up on your equity positions and see how things unfold. The Federal Reserve may also opt to maintain the status quo on its wording, at least until the first meeting of 2015.

MARKETS: The Grinch stole the Santa Claus rally, at least for a week! Despite seeing the worst week of 2014, the S&P 500 remains within 4 percent of its all-time high.

• DJIA: 17,280, down 3.8% on week, up 4.2% YTD (worst week since Sep 2011)
• S&P 500: 2075, down 3.5% on week, up 8.3% YTD (worst week since May 2012)
• NASDAQ: 4653, down 2.7% on week, up 11.4% YTD
• Russell 2000: 1152, down 2.5% on week, down 1% YTD
• 10-Year Treasury yield: 2.08% (from 2.31% a week ago)
• January Crude Oil: $57.81, down 12% on week (lowest close since May 2009; down 46% from June peak)
• February Gold: $1,190.40, up 2.7% on week
• AAA Nat'l average price for gallon of regular Gas: $2.56 (from $3.24 a year ago)

THE WEEK AHEAD:

Mon 12/15:

8:30 Empire State Manufacturing

9:15 Industrial Production

10:00 Housing Market Index

Tues 12/16:

8:30 Housing Starts

FOMC Policy Meeting begins

Weds 12/17:

8:30 Consumer Price Index

2:00 FOMC Policy Decision/Statement

2:30 Janet Yellen Press Conference

Thurs 12/18:

8:30 Weekly Jobless Claims

10:00 Philadelphia Fed Survey

10:00 Leading Indicators

Fri 12/19:

10:00 State Unemployment

10:00 Kansas City Fed Manufacturing

Near-Correction of 2014 is NOT the Crash of 1987

October, month of crashes, has brought out the bears. It has been three long years since the broader indexes have seen downside moves of 10 percent and just like clockwork, here it is October and we have finally come close to the much-anticipated correction. The selling has been attributed to a slow churn of worry, which started with concerns about global growth stalling, especially in Europe and China. The fear is that just as the US economy has found more solid footing, the rest of the world might drag down the economy and corporate earnings to boot. In the week prior, investors vacillated between confronting those fears head on, and thinking that perhaps the Fed might keep interest rates lower for a longer period of time, which would help buoy markets. The “Fed to the Rescue” rationale may have limited the initial damage to stock markets, but the bears took control last week and dumped out of stocks and poured into the safety of bonds.

It is always scary to see and hear about big point losses, but context is important. On Wednesday, the Dow Jones Industrial Average dropped by more than 460 points, which seems pretty close to the 508-point loss that occurred on October 19, 1987. That day came to be known as "Black Monday" because those 508-points represented a 22.6 percent loss in a single session, the greatest one-day percentage loss Wall Street had ever suffered.

When the Dow was at its lowest level of the day on Wednesday, it was down just 2.8 percent. In fact, at current levels, the Dow would have to plummet about 3,700 points in one day to match the damage seen in 1987. And although the financial crisis of 2008 was more severe and dangerous to the entire financial system than the crash of 1987, Black Friday remains the most dramatic day of trading that most have ever experienced on Wall Street.

Still, the October action has spooked many investors, leading some to worry that a crash—or even a bear market, which is defined as a 20 percent drop over two months, could be coming. The S&P 500 has experienced 12 bear markets since the crash of 1929, most of which occurred in, or around, economic downturns. According to Capital Economics, the current sell-off is unlikely to mark the beginning of the dreaded 20 percent drop, because bear markets do not normally occur in the middle of entrenched recoveries. “There’s nothing in the US data that has fundamentally altered our view on the outlook for the domestic economy…the near-10 percent fall in equity prices has sparked fears that something more pernicious lies ahead. But that drop in equity prices looks out of kilter with the health of the economy.”

Of course market drops could certainly wipe out a portion of household wealth, which may curtail consumer spending and hurt growth. But energy prices have plummeted alongside sagging stock prices and the net effect of lower prices at the pump should more than make up for the hit to the wealth effect from stocks. Still, for those who are worried that a crash or the next bear market is around the corner, the following aphorisms might be worth revisiting:

• Cash is King: For those investors near or already in retirement, a cash cushion of 1-2 years of living expenses can reduce the urge to panic and sell at the bottom.
• Planning is Queen: A thorough financial plan that contemplates both good and bad markets can help you navigate a crash and its aftermath.
• Diversification and rebalancing complete the Royal Family: Understanding your risk tolerance to build an asset allocation on a diversified basis, followed periodic rebalancing really can help protect your money when the next crash occurs.

MARKETS: It was a topsy-turvy week, which caused the volatility index (VIX) to surge to a 2014 high of 31.06 on Wednesday. By Friday, the VIX dropped to 22, a lot closer to its long-run average of around 20, but twice as high as the July low of 10.32 and up nearly 74 percent from a month ago.

• DJIA: 16,380 down 1% on week, down 1.2% YTD (-5.2% from all time high on Sep 19; correction at 15,615)
• S&P 500: 1886, down 1% on week, up 2.1% YTD (-6.2% from all time high on Sep 18; correction at 1817)
• NASDAQ: 4258, down 0.4% on week, up 2% YTD (-7.4% from 2014 high on Sep 2; correction at 4149)
• Russell 2000: 1082, up 2.8% on week, down 7% YTD (first weekly gain in seven)
• 10-Year Treasury yield: 2.2% (from 2.31% a week ago)
• November Crude Oil: $82.75, down 3.6% on the week
• December Gold: $1239.00, up 1.4% on the week
• AAA Nat'l average price for gallon of regular Gas: $3.12 (from $3.36 a year ago)

THE WEEK AHEAD: With stock markets wobbling, bond prices are rising, yields are falling and rates for mortgages are tumbling to the lowest levels in over a year. The housing market could use a boost, but the recent drop in rates will not provide any help until next month’s data are released.

Mon 10/20:

Apple, Halliburton, Hasbro, IBM, Texas Instruments

Tues 10/21:

eTrade, Harley Davidson, Kimberly Clarke, McDonald’s, Verizon

10:00 Existing Home Sales

Weds 10/22:

AT&T, Boeing, General Dynamics

8:30 CPI

Thurs 10/23:

3M, Amazon, Microsoft

8:30 Weekly Jobless Claims

Fri 10/24:

Colgate, Ford

10:00 Existing Home Sales

Where’s the Stock Market Correction, Dude?

As the Dow Jones Industrial Average and the S&P 500 touch new records, it’s time to review the state of the current rally.  The S&P 500 has skyrocketed about 195 percent since bottoming in 2009. That makes it the fourth-best bull market since 1928 in terms of both duration and magnitude, according to Bespoke Investment Group (via the WSJ). The market’s very strength is a bit worrisome to some traders because there has not been a 10 percent correction in over three years—as a frame of reference, corrections usually occur about every 18 months. We got close in 2012, but the last “official” one was in the summer of 2011, when the first debt ceiling crisis was raging. According to Yardeni Research, here are the recent corrections:

• 2008-2009: -57% (510 days)
• 2010: -16% (69 days)
• 2011: -19% (154 days)
• 2012: -9.9% (59 days)

Of course, just because a correction COULD be coming, does not mean you should bail out. There have been times when corrections are rare. The market avoided a 10 percent decline from 1990 to 1997 and from 2003 to 2007. The bulls point out that with the Federal Reserve keeping interest rates low, little sign of inflation and corporate earnings continuing to climb, the bull could still have room to run. The bears note that any given moment, stocks could see a dramatic reversal of fortune, at least in the short-term.

Luckily, you don’t have to time the ups and the downs of the market. In fact, if you simply adhere to your diversified portfolio, you will be able to ride out the highs and lows of the market. Of sure, there will be those who will say that it’s a "stock-picker’s market" or that a managed mutual fund will be better able to absorb downward shocks, but that’s rarely the case; and the pundits doling out that kind of advice usually have a financial incentive to get you to buy whatever it is they are selling.

The benefits of building a diversified portfolio of low cost index funds have been proven over time. Presuming that you have created an allocation according to your risk tolerance and personal goals and that you rebalance on a quarterly or semi-annual basis, there’s no need to change a thing when markets are reaching new highs or correcting.

Halftime for the Economy and YOU!

In the beginning of the year, I dusted off the crystal ball and made some predictions about 2014. At mid-year, it’s time to see how those guesstimates stack up. Economic growth: Who knew that Polar Vortex would put the deep freeze on 2014 economic predictions? We now know that the economy contracted by an annualized pace of 2.9 percent in the first quarter, the worst quarterly showing since the recession. Although Q1 will screw up the year, economists still believe that growth will increase to 3 percent by the end of the year, which would leave growth for the full year at about 2.25 percent, matching the ploddingly slow pace of the past four years.

Jobs: Back in January, estimates for 2014 monthly job creation stood at 225,000. Despite the rotten weather, job creation through May has averaged 214,000, the fastest pace in 15 yearsand the unemployment rate has dipped to 6.3 percent. Additionally, weekly jobless claims are now just above their post-recession low and are at least back down to where they were prior to the recession's start in late 2007. This year alone has seen advances; with the number of people seeking unemployment benefits falling 10 percent since the first week of January.

Housing: 2014 got off to a very slow start for housing. A combination of bad weather, low inventory and high prices in some markets reduced activity in the beginning of the year. Recent data have been more encouraging and with mortgage rates remaining relatively low and banks lending a bit more freely, housing should see progress in the second half of the year.

Investors: After the S&P 500 soared by 30 percent in 2013, expectations were pretty low for this year. Still, stocks continued to move higher, despite an early spring tech/biotech selloff. The S&P 500 managed a 6 percent gain in the first half of the year. Now the big concern is that investors have become complacent about volatility and risk.

What could go wrong? The big threat today is an escalation of violence in the Middle East, which could cause a spike in energy prices. The next biggest risk is that the Federal Reserve screws up the unwinding of its policy. If the central bank reduces its bond purchases too quickly and raises interest rates sooner than expected, the economy could falter and investors could get spooked. Conversely, going too slowly might create a speculative bubble or catch the central bank flatfooted, if inflation emerges.

All of these macro factors are out of your hands, but at mid-year, here are some actions you can take in your financial life to gain control!

Investments: Market highs are the perfect time for long-term investors to rebalance accounts so that allocations remain in check. This requires that you override your emotional urge to keep winning funds and dump those that are lagging. But that’s the point of asset allocation—various funds are supposed to move in different directions at different points in the economic cycle.

Retirement: Still haven’t calculated your number? Use EBRI’s “Choose to Save Ballpark E$timate” or check out your retirement plan/401(k) website for retirement tools.

Homeowners and Renters insurance: Don’t wait for a natural disaster to occur before you review your insurance. The three biggest mistakes that people make with their homeowners or renters insurance are: 1) under-insuring; 2) shopping for price only and not comparing apples to apples; and 3) not reading policy details before a loss occurs.

Estate Planning: PLEASE DRAFT/UPDATE YOUR WILL! I advise hiring a lawyer to prepare a will, power of attorney and health care proxy/living will. If you insist on doing it yourself, you can use a software program like Quicken WillMaker. All of your estate documents and final instructions should be stored in a safe place – don’t forget to provide copies to your executor/trustee. Those with larger estates, or who want more control over the disposition of assets, may consider a revocable or changeable trust.

Cash is King: How Nervous Investors Can Buy Stocks

The Dow and S&P 500 stock indexes are making new highs and it's been more than five years since the markets bottomed out, but that's not enough to convince many investors to jump back in. According to new research by State Street, retail investors across the globe were holding an average of 40 percent of their assets in cash, up from 31 percent two years ago. The lowest levels of cash holdings were in India, at 26 percent; the highest was 57 percent in Japan. The US was in the middle at 36 percent, but that was an increase of 10 percentage points in just two years. This jump was equal across the age spectrum: Retirees or near retirees hold 43 percent; Baby Boomers have 41 percent; Gene X are at 38 percent and the Millenials are at 40 percent. After a once in a generation financial crisis and a severe recession, these investors, regardless of age, aren’t able to stomach the market's roller coaster ride.

So should the risk averse buy back into stocks? Murphy's Law would say that the day after they do finally pull the trigger, the long-awaited for correction will come storming into town. (The S&P 500 has gone nearly two years without a 10 percent correction – the last one occurred in the summer of 2011, when the S&P 500 plummeted by more than 17 percent after the debt-ceiling debacle).

That leaves many would-be stock investors with a tough choice: should they get back into stocks after markets have more than doubled or should they remain in their cash positions? If you are the kind of person who simply cannot handle the ups and downs of the stock market, then your inclination is probably to avoid stocks at all costs. But what if you kept your stock allocation to a level where they gyrations didn’t cause you to lose sleep? Maybe a stock allocation of 10 to 20 percent of your portfolio would allow you partially participate over time, but not get your hat handed to you if/when the bottom falls out.

However, if you realize that you are ready to build a long-term investment portfolio using stocks as part of your allocation, the big question is whether to invest your cash all at once (lump sum investing or LSI) or whether to use dollar cost averaging (DCA). Dollar cost averaging is the investment strategy that divides the available money into equal parts and then periodically, putting the money to work in a diversified portfolio over time. According to research from Vanguard, two-thirds of the time, investing a lump sum yields better returns than putting smaller, fixed dollars to work at regular intervals.

The mutual fund giant analyzed returns from 1926 to 2011 and found that a lump sum portfolio comprised of 60 percent stocks and 40 percent bonds over rolling 10-year investment periods beat dollar cost averaging by 2.3 percent. In other words, if you had invested $1 million all at once, it would have led to an average ending portfolio value of $2,450,264 after 10-years, versus DCA for the same portfolio, which would have been worth $2,395,824.

The $54,440 differential may be large enough for you to go for the lump sum without looking back. But what if the lump sum decision were to occur at the beginning of a terrible 10-year period for stocks? While lump sum may beat DCA two-thirds of the time, DCA still returns more one-third of the time.

If you are the kind of investor who is less concerned with the probability of earning and more worried about losing a big chunk of money immediately, you may want to stick to DCA. Vanguard’s study notes “risk-averse investors may be less concerned about averages than they are about worst-case scenarios, as well as the potential feelings of regret that would occur if a lump-sum investment were made immediately prior to a market decline.”

It is often said that there are only two emotions in investing: fear and greed. If you are tempted to add regret to that list, tread carefully as you make this decision.

Aunt Jill on the 404: IFTTT, Apple Earnings, Credit Scores

Check my audition to be co-host of the 404 (Justin Yu is on vacation) as Jeff Bakalar, Ariel Nunez and I discuss Jeff's favorite new toy, IFTTT ("If This, Then That"); failed NYPD hashtags; a preview of Facebook and Apple earnings; and what you need to do to improve/manage your credit score (shameless plug alert: Credit.com).

Aunt Jill on the 404: Super Bowl, Stock Market Correction, Taxes

It's my first visit of 2014 with Jeff Bakalar, Justin Yu and Ariel Nunez on CNET's 404. We digest the lame Super Bowl, the sad news about Philip Seymour Hoffman, my shameless plug for the idiot-proof Ventev chargers  and of course,  I answer lots of great questions from the best fans around!

Stock market highs: Should you buy?

Dow 15,000! S&P 1600! The best start to a year for stocks since 1999! As the stock market continues its ascent, the most frequently asked question that I am receiving is:  “Should I buy or is a correction coming?” Recently on CNBC, Warren Buffett predicted that stocks will go "far higher" in the long run, so for those with 10 or 20 years to go before they need their money, there is no reason to alter your game plan – keep investing in a diversified portfolio. That said, stock indexes have gone 6 months without even a 5 percent correction – the last "classic" correction (defined as a 10 percent drop from the highs) occurred in the summer of 2011, when the S&P 500 plummeted by more than 17 percent after the debt-ceiling debacle.

So is a correction coming? Of course it is, but predicting when that will happen and trying to capitalize on it is a fool’s game. That leaves many would-be stock investors with a tough choice: should they get back into stocks after markets have more than doubled or should they remain in their cash and bond positions?

Part of the problem is that many investors are still stinging after the 54 percent drop from October 2007 to March 2009. As if that were not enough, confidence was shaken periodically during the recovery, whether from the 2010 "Flash Crash", the 2011 swoon or drops attributed to the European debt crisis. Those events may explain a recent Bankrate.com Financial Security Index, where a whopping 76 percent of respondents were just saying "no" to stocks. Economists call this “recency bias,” which means that we use our recent experience as a guide for what will happen in the future. So when stocks are soaring, we think markets will keep rising, but when the market plunges, we become convinced that it will never rise again.

But nearly 4 years since the end of the Great Recession, many investors are starting to ask whether it is safe to buy stocks. The answer is NO -- stocks are not a safe investment. If you are the kind of person who simply cannot handle the ups and downs of the stock market, then your inclination is probably to avoid stocks at all costs. But what if you kept your stock allocation to a level where they gyrations didn’t cause you to lose sleep? Maybe a stock allocation of 10 to 20 percent of your portfolio would allow you partially participate over time, but not get your hat handed to you if/when the bottom falls out.

However, if you realize that you are ready to build a long-term investment portfolio using stocks as part of your allocation, the big question is whether to invest your cash all at once (lump sum investing or LSI) or whether to use dollar cost averaging (DCA). Dollar cost averaging is the investment strategy that divides the available money into equal parts and then periodically, putting the money to work in a diversified portfolio over time. According to research from Vanguard, two-thirds of the time, investing a lump sum yields better returns than putting smaller, fixed dollars to work at regular intervals.

The mutual fund giant analyzed returns from 1926 to 2011 and found that a lump sum portfolio comprised of 60 percent stocks and 40 percent bonds over rolling 10-year investment periods beat dollar cost averaging by 2.3 percent. In other words, if you had invested $1 million all at once, it would have led to an average ending portfolio value of $2,450,264 after 10-years, versus DCA for the same portfolio, which would have been worth $2,395,824.

The $54,440 differential may be large enough for you to go for the lump sum without looking back. But what if the lump sum decision were to occur at the beginning of a terrible 10-year period for stocks? While lump sum may beat DCA two-thirds of the time, DCA still returns more one-third of the time.

If you are the kind of investor who is less concerned with the probability of earning and more worried about losing a big chunk of money immediately, you may want to stick to DCA. Vanguard’s study notes “risk-averse investors may be less concerned about averages than they are about worst-case scenarios, as well as the potential feelings of regret that would occur if a lump-sum investment were made immediately prior to a market decline.”

It is often said that there are only two emotions in investing: fear and greed. If you are tempted to add regret to that list, tread carefully as you make this decision.