First, we must step back and put the chaotic market behavior into the proper context. Many experienced market commentators believe this is not a repeat of 2008, despite outward appearances. Why is that?

The major U.S. banks are in better financial condition that when the housing market first collapsed;

Economic growth today is weak, but not non-existent as it was then;

Stock prices then were in many ways disconnected from economic reality; and

Corporations today are producing solid earnings despite the weak economy.

If there is one thing we tell our clients all the time, it’s this: “Mr. or Mrs. Client, if you’re watching television or reading the financial news, it’s critical to remember one thing—a stock index, such as the S & P 500 or Dow Jones Industrial Average, is not a measure of your portfolio. Instead, it’s what your portfolio is doing, not what “the market” is doing that matters.”

We frequently tell our clients that during bouts of volatility such as we’re now experiencing the lure of the sidelines can be very compelling. But we recommend strongly against “bailing out” and recommend the following actions instead:

First, don’t panic—if you let emotions like fear and greed drive your decisions, you’ll always be reacting to the latest news (when it’s already too late). Instead, you should deliberate quietly on your long-term goals, risk tolerance and asset allocation.

 

Second, if it’s already too late to raise cash, then make other adjustments to your portfolio allocation—but try to do so during periods of strength. One way that we’ve done this for clients is to gently revise the equity allocation downward in times of great uncertainty and heightened risk. Remember that this is to be accomplished during periods of strength, rather than weakness, and certainly should not be undertaken when the markets are in free fall.

 

Third, consider—and seriously contemplate—how you will react if the market suffers another major decline. Ideally this should be done when the “sun is shining”, i.e. during periods of strength in the market. I’ve asked clients to think long and hard about whether they have the fortitude and wherewithal to weather another deep decline. And of course, if they feel as though they might panic and sell if the market falls another 15% then I would suggest to them that their equity exposure may be too high for their risk tolerance. The first job of a financial advisor is to manage a client’s expectations of risk and to prevent surprises during severe market declines.

 

Fourth, remain engaged during troubling times in the markets. A recent article in The Wall Street Journal entitled “Don’t Join the Ostrich Generation” claims that half of investors over age 45 are paralyzed by fear to such a degree that they don’t even bother thinking about how much is needed in their retirement. The study found that many Americans are responding to the market and economic malaise by burying their heads in the proverbial sand. According to the article, investors can become frozen when they don’t know which way to go. Anytime there’s ambiguity, it immobilizes them. Of course, if you have an advisor, and that advisor is not engaged or is uncommunicative, then the problem is compounded.

In closing, I have sent clients two different links to financial articles over the past few days. Both are from www.marketwatch.com. The first article pertains to the sudden cessation of buying on the part of corporate insiders—potentially a negative sign for the markets. The second article discusses the broad concept of market direction over the longer term (through the year 2020) and references the fact that we continue to remain in the midst of a secular (long-term) bear market. I will post these two links here on my website for those of you who are interested in reading them.

Relevant Links

http://www.marketwatch.com/story/why-the-insiders-have-quit-buying-stocks-2011-09-21