5 "New" Rules For Safe Investing
Investors were hammered by massive declines as a recession swept the globe in 2008 and 2009. In the midst of the chaos, experts began calling many decades-old investment practices into question.
Is it time to try a new approach? Let's take a look at five trusted investment strategies to examine whether they still hold up in a post-credit crisis.
1. Buy and Hold
History has repeatedly proved the market's ability to recover. The markets came back after the bear market of 2000-2002. They came back after the bear market of 1990, and the crash of 1987. The markets even came back after the Great Depression, just as they have after every market downturn in history, regardless of its severity.
Assuming you have a solid portfolio, waiting for recovery can be well worth your time. A down market may even present an excellent opportunity to add holdings to your positions, and accelerate your recovery through dollar-cost averaging
2. Know Your Risk Appetite
The aftermath of a recession is a good time to re-evaluate your appetite for risk. Ask yourself this: When the markets crashed, did you buy, hold or sell your stocks and lock in losses? Your behavior says more about your tolerance for risk than any "advice" you received from that risk quiz you took when you enrolled in your 401(k) plan at work.
Once you're over the shock of the market decline, it's time to assess the damage, take at look what you have left, and figure out how long you will need to continue investing to achieve your goals. Is it time to take on more risk to make up for lost ground? Or should you rethink your goals?
Diversification is dead … or is it? While markets generally moved in one direction, they didn't all make moves of similar magnitude. So, while a diversified portfolio may not have staved off losses altogether, it could have helped reduce the damage.
Holding a bit of cash, a few certificates of deposit or a fixed annuity along with equities can help take the traditional strategic asset allocation diversification models a step further.
4. Know When to Sell
Indefinite growth is not a realistic expectation, yet investors often expect rising stocks to gain forever. Putting a price on the upside and the downside can provide solid guidelines for getting out while the getting is good. Similarly, if a company or an industry appears to be headed for trouble, it may be time to take your gains off of the table. There's no harm in walking away when you are ahead of the game.
5. Use Caution When Using Leverage
As the banks learned, making massive financial bets with money you don't have, buying and selling complex investments that you don't fully understand and making loans to people who can't afford to repay them are bad ideas.
On the other hand, leverage isn't all bad if it's used to maximize returns, while avoiding potentially catastrophic losses. This is where options come into the picture. If used wisely as a hedging strategy and not as speculation, options can provide protection.
Everything Old Is New Again
In hindsight, not one of these concepts is new. They just make a lot more sense now that they've been put in a real-world context.
In 2009, the global economy fell into recession and international markets fell in lockstep. Diversification couldn't provide adequate downside protection. Once again, the "experts" proclaim that the old rules of investing have failed. "It's different this time," they say. Maybe … but don't bet on it. These tried and true principles of wealth creation have withstood the test of time.