In the last year, markets worldwide have suffered significant losses, as the chart below from Google shows (the blue line is the Toronto TSX Index, the red line is the US NASDAQ, the orange line the US S&P 500 Index and the green line the Exchange Traded Fund from iShares that tracks the EFA Index representing Europe, the Far East and Australasia).
What, therefore, should an investor do to make the ride less stressful, since unlike a roller coaster, which is just a trivial amusement, serious savings for retirement, a house or education are typically at stake?
- Protect against drops (hedge) with options - e.g. buy put options (see Put on Investopedia); like all insurance, there is a premium so this can get expensive
- Protect against drops in stocks you own using various types of Stop Orders (see BMOIL's FAQ on Stops)
- Do the "buy low" part of the old dictum Buy Low, Sell High - the survivors of the current financial debacle might well get stronger; the challenge is figuring out whether an individual company is a winner or a loser. Diligent homework and perhaps a bit of luck is required.
- Acknowledge the difference between short term swings and longer term market upward movement and stay in the game. The Google chart below shows the same market indicators since 2002, a mere six years ago - they are still significantly positive. Cast your mind forward six years, or better 10 or 25 years, and ask yourself whether the markets will be up. Nothing in life is guaranteed and markets could stay down a long time (Japan since 1990 being an example) and if you are convinced that is the case, pull your money and stay out. The worst thing to do is to try pulling out temporarily until better days arrive - many studies have shown that investors who try to time markets this way end up losing money compared to simple buy-and-hold (e.g. How to Handle a Market Gone Mad by Jason Zweig). The roller coaster always returns intact despite the scary ride. Trying to jump out of the coaster in motion is not advisable!
- Adopt a portfolio suited to your psychology - if your ride creates real fear, maybe you should be on a tamer coaster, i.e. with less volatile investments. Maybe the girl should not have sat in front. Note in the photo how the lady in the second row seems to be calm and smiling to her child and the kids in the back are whooping it up! Partly, I believe this is a matter of getting used to it - having gone through the tech slide in 2001/02 this downturn is much less stressful for me.
- Diversify your portfolio - as noted before in this blog in posts about portfolio design, having a number of stocks will dampen the swings and minimize the impact of disasters like the Lehman bankruptcy. Mixing in fixed income will further reduce variability and downward movements.