How you react to challenging stock and bond markets will play an important role in your long-term investment success. Just as in all other areas of investing, discipline is the key. Many investors overreact to unexpected market downturns. Of course market downturns are always unexpected. Here are some guidelines that will help you to continue to invest successfully even when the financial world seems to be in the midst of collapse.
Diversification is your best defense. Spreading your money among various categories of stock, interest earning, and real estate investments has always been and will continue to be the best way to cope with unfriendly markets. That's because when some categories are diving, other categories are likely thriving or at least maintaining their value. The better diversified you are, the better position you will be in to emerge from the scary market relatively unscathed.
Always remember that you are investing for the long term. Declining stock, bond, and real estate markets aren't that uncommon. But, unless you recently got a terrible prognosis from your doctor or you're going to need a chunk of money to acquire something in the near future, you're investing for the long term, and all of the declines we have experienced in the past have been lost in the rounding. No matter how badly the markets are faring, no matter how dismal the prognoses of the pundits, a decade from now the market travails will be a faint memory.
If you must do something… It may be too much to simply sit by idly when the market is in the process of declining, particularly if you're a conservative investor and/or you're retired. So if market conditions are particularly bad or if you really fear that the stock market is headed for disaster, you could make some minor modifications to your investment diversification. I emphasize minor changes because if you start to make major shifts in investments, you are, in effect, timing the market. Market timing doesn't work, and disastrous investment markets are a relatively rare occurrence anyway.
Here's an example of a minor modification: If your current investment allocation is 60% stocks and 40% interest-earning securities, you might reduce your stock exposure to 50% if that will help you sleep better at night. But again, you risk selling stocks just before they recover. One problem with making even minor changes in your investment strategy involves deciding when to go back to your original investment allocation approach. It may be easy to lighten up on stocks when you are scared, but it's really tough deciding when to get back in.