It's funny how when the market plunges, you can feel it physically. It's that sinking feeling. It's how I felt for a brief moment on Tuesday evening, after bad economic news continued to pour in and the S&P/TSX composite had just closed 383.73 points lower at 13,357.56.
My recovery was a lot quicker than the TSX's, though. Long before Wednesday's open, I had convinced myself that there was no need to be alarmed. I took some time out to think about my investments and decided not to change a thing. I realized right then and there that I had successfully adopted one of the most resolute tenets of personal finance advisers everywhere: Have a plan and stick to it. Take it from me, it really does make you feel secure amid the volatility.
According to Christine Benz, personal finance director at Morningstar Inc., a Chicago-based investment research firm, having an investment plan is the best way to protect yourself from "making sure you're not just responding to what's happening in the market today or this week." She says it's astonishing to see the huge number of investors who, nervous by volatility in the markets, "suddenly just uproot parts of their portfolio in an effort to keep their money safe."
These investors, she says, choose to find safety in money market accounts or even by holding cash, but that security comes at a cost: Returns can be so low that it's even hard to out-earn inflation.
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That's particularly concerning because inflation is rising - Bank of Canada Governor Mark Carney said this week that the central bank expects inflation to rise above 4 per cent early next year. It means that you need to make even greater returns to cover inflation. Say you're investing in a mutual fund with fees of 2 per cent - you'll need a return of 6 per cent before you start to make any profit.
The other place where panicked investors generally move their money, Ms. Benz says, is "to whatever has been working recently." Right now in Canada, that would be energy or commodity stocks. The problem is that by the time investors decide to pull out of other investments and buy these "hot" stocks, share prices are near their highs and there's little profit left to be made.
Ms. Benz says age is the most crucial consideration in drawing up an asset allocation plan and deciding how you're going to invest. How close are you to retirement and needing that money? If you have a long time frame, say 10 years or more, invest more heavily in stocks "because that's probably your best shot at out-earning inflation," she says. It also means that you can ride out any volatility.
Ms. Benz also points out that investors are most secure when their portfolios are diversified. If you're investing in stocks, include some that pay dividends. They may seem old-fashioned, she says, but investing in some dividend-paying stocks in a company with a history of raising them "can be a very attractive place to be."
But diversification goes beyond just the kind of stocks you hold. To achieve real diversification, Ms. Benz suggests that investors look beyond their borders and their home-country biases and think globally. If markets are volatile in North America, have some of your money invested in areas of the world that are faring better. Or think about investing in an emerging market where the growth rate is forecast to be much higher than Canada's 1 per cent for 2008.
To feel perfectly safe in volatile times, Ms. Benz also believes in having an emergency fund. Financial planners always advise clients to keep a bank account with three to six months of living expenses at the ready in case something goes wrong, like you lose your job or get sick, but how many of us really do it? I don't know anyone who does, even among my most financially attuned friends.
But Ms. Benz says such a fund not only gives you the security of having a safety net, but allows you to avoid tapping into your retirement funds or borrowing on high-cost credit to make ends meet should something go wrong.
These are all great tips, but I also take comfort in knowing that although the markets are volatile, we've been here before. In fact, in my second Investor's Diary on Jan. 26, I wrote of the unsettling plunge in the markets that saw the TSX lose 6.6 per cent of its value in five days a week before, and then fall another 605 points the following Monday.
My conclusion then: I was too nervous to make any move. Well, that was then, this is now. I think I may start looking for some bargains.
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