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When stock prices are falling, some investors find themselves
trapped in a vicious emotional cycle. The thought of losing money often leads to anxiety,
and the anxiety can lead to a quick, poorly planned decision. But investors who have taken
steps to prepare their portfolio for occasional market drops are generally better able to
manage their emotions when stock prices head south.
A period of falling stock
prices—a correction or bear market—is defined
as a time when major market indexes drop at least 10%.
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Sizing
Up Your Portfolio |
| To reduce your fear of the
market correction, take time to review your portfolio.
Are all your investments in stocks or stock mutual funds?
Do you own just one stock or mutual fund? Have you invested
in only a few high-flying stocks?
Remember, all investments involve risk. As a long-term investor, you
can afford to ignore short-term price changes. But you can also make the long journey a
little more enjoyable by taking a few steps to protect your portfolio from a drop in stock
prices. Here’s a short list of some risks you face as a holder of stocks or stock
mutual funds, and some ideas about how to reduce the chances that your portfolio
may suffer a
big loss. |
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Limiting Risks |
| Market risk
is common to all investments. If stock prices fall by
10%, market risk says your stocks or stock mutual funds
are likely to drop in price as well. You can reduce the
market risk of stocks by allocating part of your portfolio
to other assets, such as bonds or bond mutual funds, Treasury
bills, or money market funds. When stock prices decline,
it’s possible that a rise in your bond or money market
investment will help cushion the fall.
Another risk to avoid is
underdiversification. If you own only a couple
of stocks, you are extremely vulnerable if one of them
suffers a big decline. Experts recommend that stock
investors hold at least eight stocks. If one stock falls
sharply, the drop will have a limited influence on your
portfolio. Also, it’s important that each of the
eight stocks be in a different industry group. Owning
eight computer-related stocks will do you little good
if the prospects dim for the computer industry. Underdiversification
also is possible with mutual funds. If you own only
one aggressive growth mutual fund, it’s likely
to fall sharply if the S&P 500 drops by more than
10%. You can temper the risk by holding a few stock
mutual funds with different investment objectives and
holdings.
Volatility risk
is a consideration, but it generally is not that important
to an investor with a long-term time horizon. Someone
who is investing for retirement in 30 years should not
be too concerned if the investment bounces around from
one day to the next. What is important is that the investment
continues to perform up to expectations. You can cut
volatility risk by investing the money you may need
in the next five years in a more conservative investment.
Be more aggressive with the money you earmarked for
use in 15 to 20 years.
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Consider
Value Stocks or Funds |
| Understanding downside risk is
critical. Owning a stock that drops 50% in value can have
a devastating impact on a portfolio. The next stock you
own would have to climb 100% to offset that initial decline.
You can potentially cut downside risk by avoiding stocks
that trade with high price/earnings ratios (share price
divided by earnings per share). When the stock market
does retreat, these expensive stocks often fall the farthest.
Look for issues with more reasonable P/E ratios—often
called value stocks—that pay solid dividends. Mutual
fund investors may want to look for funds that invest
in similar types of stocks.
Finally, investors need to be aware of liquidity
risk. If you invest in a stock that "trades
by appointment only," you may get a low price if
you are forced to sell the issue on short notice. You
can greatly reduce liquidity risk by focusing on large,
actively traded companies such as the issues that are
included in the S&P 500. Generally, mutual fund
investors do not have to worry about liquidity risk.
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A
Healthy Market Decline |
| It’s important to remember that periods of falling
prices are a natural part of investing in the stock market. While some investors will use
a variety of trading tools, including individual stock and stock index options, to hedge
their portfolios against a sudden drop in the market, perhaps the best move you can make
is limiting your overall risk position.
The most serious risk investors
face is falling short of their financial goals. Despite
several down cycles, stock prices have risen steadily
over time. Being too conservative and avoiding stocks
could limit your portfolio's return.
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This information should not be construed as
investment advice. Investors must consider their own situation before making an investment
decision.
An investor should consider
investment objectives, risks, charges and expenses of the
Fund(s) carefully before investing. Click here for a prospectus,
which contains this and other important information. Please
read the prospectus carefully before investing.
Westcore Funds are
distributed by ALPS Distributors, Inc. |
"Dow drops 161 points!" "Rocky
Road on Wall Street." With headlines like these on the front page of major papers
across the country, it’s no wonder potential investors become hesitant to get into
the market and current shareholders get nervous. If you are waiting for "the right
time" to invest, you may want to consider that market timers are usually
successful only a portion of the time. Here are some thoughts on the benefits of investing for
the long term.
