A paper published by a business professor ten years ago made this point emphatically.
The evidence from 15 international equity markets and over 160,000 daily returns indicates that a few outliers have a massive impact on long term performance. On average across all 15 markets, missing the best 10 days resulted in portfolios 50.8% less valuable than a passive investment; and avoiding the worst 10 days resulted in portfolios 150.4% more valuable than a passive investment. Given that 10 days represent less than 0.1% of the days considered in the average market, the odds against successful market timing are staggering.”
The odds of getting out of the market at just the right time and then getting back in at just the right time are roughly the same as winning the lottery.
This points out the reason why creating a portfolio that will allow you to invest for the long term is essential to creating wealth. You can achieve a decent return and sleep well at night. But in order to do this your portfolio has to match your personal risk tolerance (your Risk Number), one that differs with different people.
We are in a long-term Bull Market, but Bear Markets follow Bulls as night follows day, and some day the Bear will return. That’s when having a properly diversified, risk-tolerant portfolio pays off. Big time.
What do you do when the market drops 300 points?
Yesterday scared a lot of people. And when the July brokerage statements arrive, many people will not want to open them. It’s not been a good month for stocks.
When there’s a sudden drop in the market, one that makes people take notice, we always wonder what’s going to happen next. Is it the beginning of a steep decline, perhaps a Bear Market? Or is an opportunity to buy stocks on sale? A Blue Light Special?
The answer is: nobody knows. Anyone who pretends to know is lying.
If you have a properly constructed portfolio, what happens next won’t bother you.
By a properly constructed portfolio we mean a portfolio that’s designed to be robust, that’s properly diversified and one that is designed for your risk tolerance.
When the stock market is going up, the value of that part of your portfolio devoted to stocks increases in value. And while you may think that’s a good thing, what it’s doing is increasing the portion of your investments to stocks which are the riskiest part of your portfolio. Over time, during a Bull Market, your portfolio is becoming riskier and riskier. Unless you take active measures to bring your investments back to your original asset allocation – a fancy way of saying the portion of your portfolio that’s devoted to stocks and bonds – when the market takes a dive, your portfolio will decline more than you want.
If yesterday’s drop felt more like a drop-kick, you own too much stock. It’s time to to re-evaluate your risk tolerance. Talk to your financial advisor.
So, to answer our original question: What do you do when the market drops 300 points? If you had a portfolio that’s designed with you and your future in mind, the answer is nothing. On the other hand, if it caused you to panic, call us and let’s talk.
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