How to take action when lightning strikes your portfolio

Whenever we hear about national crises such as the credit downgrade from AAA to AA+ on Friday, August 5th, we’re always made aware of macroeconomic repercussions such as future governmental actions and the interpretations of huge investment banks including Goldman Sachs, Merrill Lynch, among others. But how are these sharp declines in the market affecting the retail traders like our parents in their retirement funds or in our college accounts?

In past articles I have written about how the last 10 years was a lost decade. Money invested in the US equity markets has languished and using the Buy & Hold strategies that most of Wall Street espouses, while charging hefty 2-3% commissions have produced negative growth and untold misery to millions of shareholders.

Granted that none of us have 401K accounts or large stock portfolios at this time, the current market that has experienced the sharpest market decline since October, 2008, is an extremely timely lesson that history is playing out before us. It gives us a reference for what we can expect in the years ahead in times of increasing volatility that will cause big swings in our future portfolios. The better prepared we are, the more pertinent questions we can ask of our financial professionals who we entrust with our hard earned money.

So, the question is what do we do when Lightning strikes? When we are fully invested, and the world equity markets tank, how do we react, or do we just sit back and passively watch?

When we left for the summer break in May, the S&P was roughly at 1338, and at the close of last Friday it was down 184 points to 1154, a loss of 14%! We are down 8% from January 1st (-103 points), and most fund managers are deep in red all across the board.

Many people are faced with the predicament of being “long,” or buying to own, a stock during a financial calamity. The companies held in an investor’s portfolio that were perceived to be rugged, reliable and upward-trending businesses are all of a sudden volatile and risky. During market volatility, even the strongest of companies tend to sell off. It is important to have a plan for all situations and not fall into the two human attributes that constitute the marketplace: fear and greed.

When one is paralyzed by fear, there is a saying that the best time to plant a tree is 20 years ago but the second best time is right now. Problems need to be confronted. Don’t succumb to the panic sell: taking a big loss and relocating all of your cash to under your mattress. Greed can also be your worst enemy if you fall into the “it will come back” crowd, because the market does not care where you got in or where you get out.

When lightning strikes, here are some pointers worth considering:
1. Institutions respect the 200 moving day average, and once stocks and indexes break the average, the dumping of shares intensifies. It may be prudent to accumulate shares above the average, and sell shares as it dips below the average.

2. If global markets are selling off, and stock prices are tanking, consider selling half your position, and raise cash positions. Selling some fraction clears one’s head, reduces the panic, and also minimizes losses, as now only a portion of the position is losing value, instead of the full, original position.

3. Sell the losing positions, while keeping the winners. This weeds out the weak stocks and rebalances the portfolio.

4. Cash is king. Raise additional cash reserves and keep it ready to re-deploy it to buy your favorite companies at bargain basement values, when the time is right to re-enter the market.

5. Research and learn to hedge long positions with vehicles such as gold and precious metal ETF’s (Exchange Traded Funds) that often appreciate, as investors flee to safety.

6. Diversify among different asset classes so the risk of one asset class depreciating rapidly is mitigated by gains in other vehicles.

9. Scale into the same stocks at lower prices, in a disciplined monthly allocation, to reduce the cost basis of each equity position.

10. Most market downdrafts cycle through periods ranging from a few months to a few years, so maintaining a long term view combined with an upward bias in the equity markets should bail out most losing positions, over time.

Remember: The current situation, too, shall pass.

Investment guru Warren Buffett often makes a comparison to the price of hamburgers at McDonalds. If the price tag is reduced he doesn’t get worried, he buys more and feels good that he’s paying less for the same hamburger than it would have cost him the day before.

It’s a good time to remember one of Warren Buffett’s rules: Be fearful when others are greedy, and be greedy when others are fearful.”

Aliya is a sophomore. You can reach her at apadams1@swarthmore.edu.

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