How to Weather a Stock Market Correction - Monday, July 07, 2008

How to Weather a Stock Market Correction

Monday, July 07, 2008

Shank Wealth Management

Missing the market�s top-performing days can prove costly. This chart shows how a $10,000 investment would have been affected by missing the market�s top-performing days over the 10-year period from December 31, 1997, to December 31, 2007. For example, an individual who remained invested for the entire time period would have accumulated $17,758, while an investor who missed just five of the top-performing days during that period would have accumulated only $13,782.

When stock prices are falling, some investors find themselves trapped in a vicious emotional cycle: fear of losing money often leads to anger, and anger can lead to a quick, poorly planned decision. But investors who have taken steps to prepare their portfolio for occasional market drops generally are better able to manage their emotions when stock prices head south. A stock market correction is defined as a time when major market indexes drop between 10 percent and 20 percent. Declines greater than 20 percent are considered to be bear markets. In the past 10 years, Standard & Poor�s Composite Index of 500 Stocks has experienced a correction several times, and a bear market early on in the new millennium.

Sizing Up Your Portfolio

If confronted with a market correction or bear market, take time to review your portfolio. Are all your investments in stocks or stock mutual funds? Do you own just one stock 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 help 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 suffers a big loss.

Limiting Risks

Market risk is common to all investments. If stock prices fall, market risk says your stocks or stock mutual funds are likely to drop in price as well. You can reduce market risk to stocks by allocating part of your portfolio to other assets, such as bonds or bond mutual funds and 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 only own a couple of stocks, you are extremely vulnerable if one 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 when the prospects dim for the computer industry. Underdiversification is also a risk 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 percent. You can temper the risk by holding a few stock mutual funds with different investment objectives.

Volatility risk is a consideration, but it generally is not as 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.

Bill Shank & Christian Shank

Shank Wealth Management

900 Rockmead, Ste. 265

Kingwood, Texas 77339

281-359-3133

www.shankwm.com

Securities offered through LPL Financial. Member FINRA/SIPC

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This article was prepared by LPL Financial Research. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult me prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.