Highs and Lows

Utah Valley Business Q

After spending most of the year in a back-and-forth uneventful trend, the world markets abruptly changed course. A severe lack of fiscal leadership from Washington coupled with a sovereign debt mess in Europe caused the global markets to sell off hard.

This recent volatility has been the most extreme we have experienced since the 2008 meltdown. I don’t remember a time there has been so many huge, back-to-back, up-and-down market moves in a row. On a regular basis, the Dow Industrials has been losing or gaining 400, 500 and 600 points at a time.

This type of volatility can make the most seasoned investor a little queasy. The volatility, accompanied by the endless negative news — real and imagined — is enough to make investors question if there is anywhere safe to put their money.

Studies have shown most investors consistently underperform the market indexes. The reason they underperform is because they sell out of their investments when they get scared and then go back into them once they feel safe. Investing based on feelings is a recipe for buying high and selling low.

So what should an investor do in these difficult times? How do you avoid selling low and buying high? Here are three basic rules I recommend.

Rule #1: Never sell out during panic.
Wait for sanity to return before you make any changes to your portfolio. When the markets are moving 500 to 600 points a day, it represents extreme panic. The stock market is essentially a high-tech auction. If you try to sell at the same time as everyone else, there are very few buyers. Those few buyers can essentially name the price they are willing to pay you. That price will be well under fair value.

Rule #2: Establish your risk tolerance BEFORE you invest.
You need to define in advance how much risk you are comfortable with. Investors often ignore this step. Then, when markets become volatile, they become painfully aware their risk tolerance is not set properly. Making the effort to set your risk tolerance initially — and reassessing it annually — is critical to your long-term success.

Rule #3: Keep your focus on the long term.
Mistakes are often made when investors make emotional decisions based on short-term market action. Unfortunately, decisions based on short-term market movement can have long-term negative consequences. Your investment strategy should be based on your long-term goals and objectives. While your plan should be reviewed and adjusted annually, it should not be drastically changed, especially when markets are volatile. Define your long-term investment plan when markets are stable.

What can investors expect going into the end of the year? Usually markets will do whatever the majority doesn’t expect, and right now most investors are scared and expecting the worst. We don’t expect another recession soon based on the current economic numbers we track. That may change, though, if Europe doesn’t deal with its debt problems or U.S. consumers scare themselves silly and pull back on consumer spending. Unfortunately, recessions can be self-induced.

On a positive note, historically, the third year of every president’s term since 1939 has been positive for the markets — even during Jimmy Carter’s presidency. In addition, surprisingly, the S&P 500 has produced a positive return for the final four months of the year during seven of the last eight years.

To learn more about how to implement these strategies, go to paragonwealth.com. Or for regular strategy updates, follow us on moneymanagerslive.com.