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Dave Patterson and Erin Preston, a father-daughter team of Certified Financial Planner® licensees, provide thoughts and suggestions on a broad collection of personal finance topics.  Information provided in this BLOG is intended to be of a general nature and may not be appropriate for all situations.  Readers should consult with their own financial advisors before relying on any information contained herein.

Friday, May 7, 2010

Yesterday’s Lesson

As most everyone knows, yesterday was a wild day on Wall Street, with the Dow Jones Industrial Average (DOW) plunging in a matter of minutes in mid-afternoon. The drop of nearly 1,000 points was followed by a rally, with the Dow ending the day down some 347 points (but up over 600 points from the low of the day). At the time of the severe drop, the market was already down significantly due to concern that the economic crisis in Greece could spread to much of Europe.

Newspaper reports indicate that a clerical error in one trade may have triggered computer trading systems to rapidly sell. It was reported that a trade for $16 million dollars was erroneously entered as $16 billion.

So what can we learn from what happened yesterday? Clearly, there were investors hurt as they panicked and sold at the bottom, locking in their losses, only to see the market recover a short time later. Others may have profited by buying at the bottom. If you consider yourself a long-term investor, however, you need to stay calm and ignore what’s happening in these market swings.

We’ve written time and time again that it’s very tough to time the market. You have to be right twice. You have to know when to get in and when to get out. Making that call just once is very tough to do, especially in the volatile world we live in.

Just think of all the unusual events that have occurred recently that could have significantly impacted world economies. We’ve had earthquakes, volcanic dust, an oil spill that is threatening the entire Gulf Coast, and now, unrest in the European economies. These events come and go. History has shown us that in times of crisis, the market usually recovers quite quickly.

If your emotions cause you to panic and sell in such a situation, you likely have too much invested in the stock market or don’t have your goals aligned with your portfolio. Money needs to be set aside in safe, short-term securities to meet short-term goals. If you are trying to juice your returns by increasing your investments in riskier assets, you will likely find it difficult to ignore wild market swings.

Investors need to have their portfolio risk tuned to their risk tolerance and goals in order to avoid letting their emotions drive their investment decisions. Broad diversification with periodic rebalancing (at least annually) should serve you well. Rebalancing helps you buy low and sell high. With the appropriate risk tolerance, aligned goals and some discipline, you can avoid letting events such as yesterday’s wild market cause you to let your emotions get the best of you.


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