By Jill Schlesinger
Tribune Content Agency
Stocks have plunged for the second time in six months, and the big swings are testing every investor's internal fortitude. The bad start to the year is even stirring grim memories of 2008, especially given the dire predictions of some economists and analysts.
The current situation is not like 2008, primarily because there is no financial crisis brewing. In fact, corporate balance sheets (outside of the energy sector), including those of financial services companies, are in decent shape. Additionally, despite slowdown fears, the U.S. economy, while not strong, is still growing by about 2 percent annually. That means in a year like 2015, you have soft quarters like Q1 and Q4 where there is barely any growth (0.6 percent and an estimated 1 percent, respectively), and stronger ones like Q2 and Q3, where the economy seems fine (3.9 percent and 2 percent growth).
Still, it's hard not to feel butterflies when big bank economists such as Andrew Roberts of Royal Band of Scotland say things like: "The downside is crystallizing. Watch out. Sell (mostly) everything." Although some investors may be tempted to sell, they do so at their own peril. Market timing requires you to make two precise decisions - when to sell and then when to buy back in - something that is nearly impossible. After all, even if you sell and manage to steer clear of the bear by staying in cash, you will not be able to reinvest dividends and fixed-income payments at the bottom and you are likely to miss the eventual market recovery.
In fact, data from the research firm DALBAR confirm that when investors react, they generally make the wrong decision - which explains why the average investor has earned half of what they would have earned by buying and holding an S&P index fund. We'll see if the folks at RBS can beat the odds.
The best way to avoid falling into the trap of letting your emotions dictate your investment decisions is to remember that you are a long-term investor and you do not have all of your eggs in one basket. Try to adhere to a diversified portfolio strategy, based on your goals, risk tolerance and time horizon, and do not be reactive to short-term market conditions. Over the long term, this strategy works. It's not easy to do, but sometimes the best action is NO ACTION.
If you are really freaked out about the movement in your portfolio, perhaps you came into this period with too much risk. If that's the case, you may need to readjust your allocation. If you do make changes, be careful not to jump back into those riskier holdings after markets stabilize.
If you have cash that is on the sidelines and are nervous putting it to work as a lump sum, you should take heart in research from Vanguard that shows that two-thirds of the time, investing a windfall immediately yields better returns than putting smaller, fixed dollars to work at regular intervals.
But if you are the kind of investor who is more worried about losing a big chunk of money immediately, you may want to stick to dollar cost averaging. Vanguard notes that "risk-averse investors may be less concerned about averages than they are about worst-case scenarios, as well as the potential feelings of regret that would occur if a lump-sum investment were made immediately prior to a market decline."
Contact Jill Schlesinger, senior business analyst for CBS News, at askjill@JillonMoney.com.
This article was printed in the February 7, 2016 - February 20, 2016 edition.