4 Tips For Navigating A Difficult Market

At times like these it seems almost impossible to be optimistic about the future.  The stock market is reeling, yields on high-quality bonds are anemic, and everywhere you turn there’s a new disaster.  Wall Street banks are bleeding red, mortgage companies are dropping like flies, commodity prices are through the roof, and inflation is poised to rear it’s ugly head.  But are things REALLY as bad as they seem?

Valuations Are Reasonable

This isn’t 1999.  The MSCI US Broad Market Index is currently selling for around 16 times earnings as opposed to nearly 30 times earnings at the apex of the tech boom.  Even assuming corporate earnings stay flat where they are and never grow again (any extraordinarly unlikely possibility) and the market multiple retracts to an equilibrium of around 12 times earnings, we’re still looking at a long-term estimated return of around 5.5% per year (6.25% earnings yield plus 2% dividend yield times 0.35 to accomodate the lower multiple).  And this is in the absolute WORST plausible scenario.  It’s more likely long-term returns will be in the 8-9% range (or 4% to 5% after inflation).  Put into perspective, this is as good a time as any to invest.  Here are four tips to guide you.

• Re-evaluate Your Risk Tolerance - If you’re having trouble sleeping at night amid the recent market turmoil, chances are you’re investing beyond your risk tolerance.  If you find yourself agonizing over whether or not you should move your 401k into a money market fund, you’re investing beyond your risk tolerance.  If so, you should develop a new, more conservative asset allocation plan; one you can live with in good markets or bad.  If that means having 40% of your money in bonds in your 20’s, so be it.  It’s better to invest conservatively than attempt to invest beyond your risk tolerance and panic at the wrong moment.
• Continue Dollar-Cost Averaging into your Retirement Account - This goes back to your risk tolerance.  If you are tempted to stop new contributions to your retirement account because the market is down, you are investing beyond your risk tolerance.  If you are confident in your plan, stick with it.  Bear markets never last forever.  In fact, they rarely last more than a year or two.
• Stay Broadly Diversified - Diversification matters more than ever in a bad market.  You may be tempted to move all your money into bonds or commodities or some other sector that seems to be holding up well against the odds.  Don’t.  Nobody can time the market and more often than not, you will do yourself permanent long-term harm in the attempt.
• Boost Your Emergency Fund - The usual advice is to keep between 3 - 6 months worth of expenses liquid in your emergency fund.  This is excellent advice, but in a downturn, you may be more exposed to losing your job.  If you work in a volatile industry (maybe a Real Estate Agent or Mortgage Broker as a current example), you may want to boost your emergency fund to 9 or even 12 months worth.  Better safe than sorry.