Keeping your cool can be hard to do when the market goes on one of its periodic roller-coaster rides. It's useful to have strategies in place that prepare you both financially and psychologically to handle market volatility.

Have a game plan against panic
Having predetermined guidelines that anticipate turbulent times can help prevent emotion from dictating your decisions. If you're an active investor, a trading discipline can help you stick to a long-term strategy. For example, you might determine in advance that you will take profits when the market rises by a certain percentage, and buy when the market has fallen by a set percentage. Or you might take a core-and-satellite approach, combining the use of buy-and-hold principles for the bulk of your portfolio with tactical investing based on a shorter-term market outlook. You can use diversification to offset the risks of certain holdings with those of others. Diversification may not ensure a profit or guarantee against a loss, but it can help you understand and balance your risk in advance.

Consider playing defense
Many investors try to prepare for volatile periods by reexamining their allocation to such defensive sectors as consumer staples or utilities (though, like all stocks, those sectors involve their own risks). Dividends also can help cushion the impact of price swings.

Use cash to help manage your mindset
Cash can be the financial equivalent of taking deep breaths to relax. It can enhance your ability to make thoughtful decisions instead of impulsive ones. If you've established an appropriate asset allocation, you should have enough resources on hand to prevent having to sell stocks to meet ordinary expenses or, if you've used leverage, a margin call. A cash cushion coupled with a disciplined investing strategy can change your perspective on market downturns. Knowing that you're positioned to take advantage of a market swoon by picking up bargains may increase your willingness to be patient.

Know what you own and why you own it
When the market sneezes, knowing why you originally made a specific investment can help you evaluate whether those reasons still hold, regardless of what the overall market is doing. If you don't understand why a security is in your portfolio, find out. A stock may still be a good long-term opportunity even when its price has dropped.

Remember that tomorrow is another day
The market is nothing if not cyclical. Even if you wish you had sold at what turned out to be a market peak, or regret having sat out a buying opportunity, you may well get another chance at some point. Even if you're considering changes, a volatile market is probably the worst time to turn your portfolio inside out. A well- thought-out asset allocation is still the basis of good investment planning.

Be willing to learn from your mistakes
Anyone can look good during bull markets; smart investors are produced by the inevitable rough patches. Even the best aren't right all the time. If an earlier choice now seems rash, sometimes the best strategy is to take a loss, learn from the experience, and apply the lesson to future decisions.

Review your tolerance for volatility
Have a conversation with your Stage 2 Associate to see if your asset allocation fits your long-term goals. Sometimes having a conversation with one of our investment professionals will help you understand the decisions you made. Staying true to your long-term goals is one of the indicators of a successful investment program.
Diversification does not guarantee against loss. It is a method used to help manage investment risk.

With warm regards,

Stage 2 Planning Partners

Josh Patrick © 2007

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