One of my favorite investment sayings is attributed to value investing legend Shelby Cullom Davis: "You make money during bear markets; you just don't know it at the time."
Davis' point, much like Warren Buffett's oft-quoted "be greedy when others are fearful" advice, is that opportunistic contrarians can set their portfolios up for great returns by buying when and what others are selling.
Unfortunately, many investors also lose their money during weak markets. They panic-sell and upend what had seemed like sensible investment plans when cooler heads prevailed. Then, when the market inevitably begins to ascend again, they're left with that nagging question: Is now the time to get back in? I'm still getting emails from people who moved to cash during the last downturn.
But telling people to stay cool or go run around the block (my mom's favorite advice for restless kids) can seem platitudinous on days when the market drops by 500 points. And let's face it--as with most weak markets, there are scary headlines out there: gloomy economic news here at home, combined with concerns that Europe's current debt crisis is more widespread than initially feared. If you were among those many investors compulsively hitting "refresh" on your computer for market news on Thursday and Friday, I can hardly blame you.
One way--really the only way--to stay grounded at times like this is to concentrate your energies on your own portfolio and your own financial status. Changes may indeed be in order for your investment program, but you won't know that without conducting some analysis. Your best first investment during turbulent markets is an investment of time. You want to invest in time to see where you stand now, and, if you determine changes are in order, thoroughly research your options.
Here's your five-step checklist for times such as these.
Step 1: Check adequacy of cash reserves.
By far the best way to manage your portfolio--and your emotions--during volatile markets is to make sure that you have adequate cash on hand to cover your near-term needs. That way, your long-term stock investments can do what they're going to do, but you can take comfort in knowing that it won't affect your ability to pay your grocery tab or the bill for next year's college tuition. For retirees, that means that you need to hold one to two years' worth of living expenses (those expenses that are not covered by any other regular income you have coming in the door) in cash.
You can then stage the rest of your money in progressively more aggressive/long-term investments. (This article discusses how to employ what's often called a "bucket" approach to retirement income.) Folks who aren't yet retired can run with smaller amounts of cash--three to six months' worth of living expenses, plus enough to cover any near-term bills that you can't fulfill with your regular paycheck is a good rule of thumb. Don't include any residual cash in your long-term investment holdings--such as stock or bond funds that are holding cash--when you do your tally.
Step 2: Check your long-term positioning.
Once you've done the liquidity check, the next step is to check the asset allocation of your long-term assets. Market sell-offs can be alarming for retirees and people getting close to retirement simply because they typically have more money invested, period, than do their younger counterparts. For example, someone with an $800,000 portfolio that's split 60/40 between stocks and bonds would've lost about $25,000 on Thursday alone. But particularly jarring losses can be symptomatic of a problem that needs addressing. You might have too much in stocks given where you are in your life stage; this article provides some guidance for making sure your stock/bond split is in the right ballpark.
Alternatively, you might have your asset allocation right, but your subportfolio allocations skew too heavily toward aggressive investments. For example, your equity portfolio might lean heavily on small- and mid-cap stocks or your bond portfolio has too big an emphasis on corporate bonds rather than the government issues that tend to hold up better when recession worries grip the market. Morningstar's Instant X-Ray tool can help you identify unintended bets that expose your portfolio to extra risk.
Step 3: Initiate defensive hedges with care.
As the stock market has swooned, a very small handful of the usual suspects have actually benefited: gold, U.S. Treasury bonds, and bear funds that are shorting stocks. I hope the long-term performance pattern from bear funds is enough to deter you from monkeying with one of these investments; nearly every fund in the group has a negative to scarily negative five-year return, and these funds' short-term performance gyrations can also be unnerving. Gold and Treasuries, meanwhile, can serve a much more legitimate defensive role in a portfolio. The problem with them, however, is that both investment types have already enjoyed a sizable runup. So if you're moving into either, do so very slowly, and only after you've checked your existing exposure to those asset classes; if you own funds run by active managers, those managers might have already beaten you to the punch.
Step 4: Make sure you're taking advantage of "gimmes."
In unsettling times, the most empowering strategies are those that stick within your sphere of control. Checking your long-term asset allocation and cash reserves clearly falls under the "in your control" heading, and so does carefully calibrating what you put into--and what you take out of--your portfolio. It might seem obvious, but boosting your own savings rate (or making sensible cutbacks to your withdrawal rate, if you're already retired) is a guaranteed way to increase the size of your nest egg. So if you haven't revisited your contribution rate for a while, now is a good time to do so. It also makes sense to prioritize saving within any tax-sheltered wrappers you have available to you; Roth IRAs and 401(k)s are particularly sensible if you're concerned that taxes could head higher in the future.
Step 5: Develop a strategy for deploying cash.
Now, back to the Shelby Cullom Davis quote that I used to kick off the article: The best way to make money is to be willing to invest when others are afraid to do so. So if you have cash to invest or are in the process of moving around already-existing holdings, do so with a contrarian mind-set. We've recently published a series of articles and videos about 
stocks and ETFs that appear attractive to our analysts on a bottom-up basis. I'm also a big fan of Morningstar's Market Fair Value graph and ETF Valuation Quickrank when I need to get a quick read on what parts of the market appear cheap and which parts are still pricey.
Original article via here
With the current turbulence in world and local financial markets, now more than ever a disciplined approach to investing is vital. An excellent article, mind you a bit advanced for beginner investors, from Christine Benz, director of personal finance, on Morningstar. We're here to break this down for you, feel free to keep leaving us questions by email or here on the blog.
Happy Investing,
The 360 Investing Guys
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