Don't Get Rattled by Wall Street's Bumpy Road
In the investment world, these are no ordinary times. Consider the following:
On Sept. 15, the Dow Jones industrial average fell more than 500 points - the biggest point drop since the September 2001 terrorist attacks. Following this decline, the market was down about 23 percent from its all-time high last October.
Facing big losses, two big names on Wall Street - Merrill Lynch and Lehman Brothers - took drastic steps to rescue their respective businesses, with Merrill Lynch selling itself to Bank of America and Lehman Brothers filing for bankruptcy protection.
The U.S. government has bailed out investment bank Bear Stearns, mortgage finance giants Fannie Mae and Freddie Mac, and American International Group (AIG).
What's behind this slew of bad news? Several factors are involved, but a key culprit is the subprime mortgage crisis, which resulted in enormous losses suffered by financial institutions.
Of course, we've seen large market declines before, but what's happened to these major players in the investment world is something new for most of us. And yet, you shouldn't confuse the problems of certain financial services providers with the viability of our financial markets as a whole. We still have the most powerful and resilient economy in recorded history, and investment opportunities still abound.
Nonetheless, as an individual investor, you'll find it hard to ignore the recent market turmoil. How should you respond to this level of volatility?
Patience - It's usually not a good idea to let short-term market movements dictate your long-term investment strategy. If the current market decline led you to take a "time out" from investing, you might feel better for a few weeks or months, but you wouldn't be helping yourself achieve your long-term financial objectives. In the past, the market has fallen sharply after a variety of events - wars, assassinations, terrorist attacks, natural disasters, corporate scandals and so on - only to regain its footing and move on to new highs. And since the biggest gains can occur in the early stages of a market turnaround, you could miss out on the possibility for considerable growth if you're sitting on the investment sidelines.
Diversification - If a market downturn primarily affects just one type of asset, such as domestic stocks, and your portfolio is dominated by that asset, you could take a big hit. But if you broaden your holdings to include international stocks, bonds, Treasury securities, certificates of deposit (CDs) and other investments, you can potentially reduce the effects of market volatility. (Keep in mind that diversification, by itself, cannot guarantee a profit or protect against a loss.)
Quality - During market downturns, even quality stocks can lose value. But these same stocks have the potential to recover when the market turns around. Look for good, solid companies whose products are competitive and whose management has enunciated a strategy for future growth.
The last few months have been difficult ones for investors, and we may still have some rough roads ahead. But by showing patience, diversifying your holdings and buying quality investments, you can continue to make progress toward your long-term goals - in markets that are good, bad or indifferent.