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Every day it seems you're bombarded with reports of turbulent economic conditions and feel it's time to get out of the market and stash your cash under the proverbial mattress. However, selling during a market dive could actually realize your losses, not cut them.
Selling when the markets become choppy or decline rapidly is one way investors chase performance. Market volatility can be unnerving, but fear of short-term loss is a flawed reason for taking action. If you sell to simply avoid negative performance, you're in danger of being on the sidelines during market upswings, which often come unexpectedly and are strong in their early stages.
During an up market, the desire for rapid or impressive gains makes it hard to stick to an investment plan over the long term. Many investors want to believe that an investment's past performance is indicative of its future results, despite warnings to the contrary. They find themselves tempted to scoop up today's "market darling." The problem is, today's best performers could be tomorrow's biggest losers.
Missing even a few days of a market turnaround can have a significant effect on your returns. For example, if you invested a hypothetical $10,000 in an investment that performed similarly to the S&P 500 Index from December 1991 to December 2006 and didn't touch it, the $10,000 would have grown to $45,579. If you missed even the 10 best days of the stock market during that 15-year period, your investment would have grown to only $28,397. And if you missed the stock market's best 50 days, your $10,000 investment would have been worth $8,141.
Buying stocks or funds based on their recent performance or selling them as soon as they begin to decline is a recipe for buying high and selling low- the exact opposite of successful investing.
This information is for illustrative purposes only and is not intended to represent any particular investment product. Past performance is not a guarantee of future results. The S&P 500 Index is a capitalization-weighted index of 500 widely traded stocks. Created by Standard & Poor's, it is considered to represent the performance of the stock market in general. It is not an investment product available for purchase.
Research shows that investors typically focus nearly all of their attention on trying to identify the best stock or mutual fund and almost no time on asset allocation or risk tolerance. But in reality, the most successful investors are ones who map out an asset allocation plan that's appropriate to their goals, investment time frames and tolerance for risk, and then stick with it over the long haul. Research has shown that 90% of a fund's return over time was based on how its assets were allocated and not on its specific investments2. The same can be true for your portfolio.
When picking funds or stocks, it's important to consider your investment goals, time frame, and comfort level with risk. Create an asset allocation plan-a target mix of stocks, bonds, and money market securities-and then diversify your investments using factors such as market sectors and investment styles. Choose investments that you intend to hold for a long time. Assuming your asset allocation and diversification are appropriately matched to your goals and tolerance for risk, market volatility may not be so unsettling. Of course, this strategy does not ensure a profit. It is possible to lose money with an asset allocation and diversification plan.
It's also important to fairly judge your investment's performance. Instead of looking at day-to-day price movements, look at the bigger picture. Compare your fund's performance to that of its peer funds or benchmark index. With individual stocks, revisit your reasons for buying them-such as a targeted growth rate or reliability of dividends-to see if anything has changed. By focusing on the fundamentals, you'll make decisions based on your original convictions rather than on short-term performance.
When it comes to your long-term goals, your wisest course of action is to stick to your investment plan. Keep your eyes on the goal-accumulating the assets you need further down the road-and keep in mind that money invested for long-term goals should not be disturbed due to short-term market fluctuations. Never let a short-term event affect your long-term plan.
Your investment goals are important. Reaching them requires careful planning and a little self-discipline. Remember that your investment return and principal value will fluctuate, and it is possible to lose money by investing. Past performance is not a guarantee of future results. But you may be able to save yourself some unnecessary stress and anxiety in the short-term if you have a long-term investment plan and you stick with it.
1 Source: Bloomberg. This hypothetical investment is for illustrative purposes only and is not intended to represent any particular investment product. Past performance is not a guarantee of future results. The S&P 500 is a capitalization-weighted index of 500 widely traded stocks. Created by Standard & Poor's, it is considered to represent the performance of the stock market in general. It is not an investment product available for purchase.
2 Source: "Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance?" by Roger G. Ibbotson and Paul D. Kaplan, ©2000, Association for Investment Management and Research.
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