I was waiting for a flu shot at a local pharmacy this week when a money-manager friend of mine walked out of the vaccination area, rolling down his sleeve.
“Now,” he said, “if I could just get a shot that would protect me from whatever the market is about to do.”
Alas, there’s no way to truly inoculate yourself against the next market malady. In fact, the similarities between the mystery strain of market flu still on the horizon and the variety of influenza sweeping the country are interesting, as are the psychological reactions of people who are worried about getting sick.
With my wife working a new job where she comes into contact with a lot of people every day, and with more news outlets reporting on the rampant spread of the flu this season, in our household, there’s recently been a level of fear about getting sick that we don’t normally experience.
It made us want to act, to do something.
And that is precisely the same kind of emotion afflicting many investors.
Worse yet, I had not been back from the pharmacy an hour before I saw two news reports talking about how and why the flu-epidemic story is a trumped-up media creation.
While I don’t regret getting the shot, those reports left me feeling like I had probably shelled out money for protection that ultimately was not necessary.
There’s a cost associated with worry and protection. That, too, is common with investors.
Consider how the statistics showed money flooding into bond funds last year and fleeing equities. Ask average investors about their thought process and they’ll say their goal was to avoid the potential for stock market losses at a time when the market was volatile. For investors who stayed on the sidelines during 2012, they “protected” themselves out of a 16 percent gain in Standard & Poor’s 500-stock index.
“I think the main thing people need to protect themselves against is knee-jerk reactions based on the fear generated from sensational headlines,” says Diahann Lassus, a financial adviser with Lassus Wherley in New Providence, N.J. That includes fears concerning the fiscal cliff and others that “create terror because most people don’t know who to believe,” she says.
Indeed, the problem is strong desire to “do something.” Norman Boone, president of Mosaic Financial Partners in San Francisco, says that protection against the next Asian contagion or market malaise should be built into most people’s long-term planning, making it possible to ignore the headlines.
“Lacking that, Boone worries that people will fall victim to the ridiculous and end up using their expertise to anticipate what changes the market is going to make and move things around in (their) portfolio, regardless of tax consequences, and make adjustments as often as (they) think market volatility is coming.”
That, effectively, is protecting yourself to death.
And, indeed, most volatility is the common, garden-variety stuff that creates wealth-building opportunities, rather than the crushing problems of the financial crisis of 2008.
“While each individual or family is different, we can all take certain precautions to help protect our investments from getting sick, including appropriate diversification based on our personal goals, rebalancing when our portfolio drifts, reducing expenses where appropriate, and saving an adequate amount to put us on track toward achieving our goals,” says Dan Dorval, CEO of Dorval & Chorne Financial Advisors in Maple Grove, Minn. “If we still get sick – and we will – then we respond with treatment to limit the adverse impacts of illness and try to help improve recovery time.”
So how do nervous investors protect themselves against short-lived financial flu?
Experts suggest several steps besides diversification:
• Keep a cash cushion. For many people, there’s a peace of mind that comes with knowing your money is “there” — or at least that enough of it is there to tide you over through any problems. “For most investors, breathing comes easier if they know they have dollars set aside,” says Peg Eddy, president and co-founder of Creative Capital Management in San Diego.
• Hedge your bets. Whether it’s options, collars or variable annuities, consider tools that could protect your gains if the market’s ills cause you to retch. That said, be sure to consider the costs carefully, because there are plenty of times when the costs to avoid a few days of discomfort are more than what the market is likely to dish out.
• Control risk and manage volatility. Bonds and cash may not be earning much these days, but they do help manage the risk level of a portfolio. Rebalancing a portfolio – culling your winners and reallocating money back to targeted levels – has proved an effective risk-control method.
• Focus on your long-term financial health, rather than the market’s short-term ills. If you can’t correctly anticipate market changes – and you can’t, especially if they are caused by surprise events – stick to the plan and the investment policies that have gotten you this far.
• Fight the next market malady, not the last one. Investing to avoid the market’s most recent problems is how a lot of investors end up with negative returns in solid markets. It’s also how many people wound up avoiding stocks last year and missing out on double-digit gains. They “avoided” problems that did not reoccur, but their portfolio isn’t healthier for the choices they made.Chuck Jaffe is senior columnist for MarketWatch. He can be reached at firstname.lastname@example.org or at P.O. Box 70, Cohasset, MA 02025-0070.