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5 Lessons on Investing for the Market Weary

Reprinted courtesy of MarketWatch.com.

To read the original article click here

Two weeks ago the stock market tumbled, freaking out all sorts of investors. First there were the “bond bears” who bailed out of fixed-income funds because they “just knew” they were about to lose money big-time in bonds. Then there were the equity investors who had to deal with sudden gut-wrenching drops in the stock market.

Undoubtedly, many of the bond bears who had just exited felt foolish when the falling stock market gave bond prices a sudden boost. They can be forgiven for wondering what they did wrong.

Lots of equity investors, meanwhile, reached their maximum frustration level and cut way back on their exposure or got out of the market completely. Last weekend, faced with headlines about the stock market’s best week in nearly two years, these bears could be forgiven for wondering what they did wrong.

I think it’s time for nervous, frustrated investors to go back to Introductory Investing 101, a class that is taught by the markets every business day.

Lesson 1: The stock and bond markets are supposed to go up and down. This is normal.

Lesson 2: The markets are very often full of surprises. Nobody can reliably and accurately predict the short-term future. This is normal.

Lesson 3: Investors in equity funds are virtually guaranteed to lose money. This is normal.

Lesson 4: The losses referred to in Lesson 3 are usually temporary. That’s because the long-term trend of the stock market has been going up for the last two centuries.

Lesson 5: To deal successfully with these well-known lessons, investors have to do a little work.

That “little work” involves knowing yourself. As the old saying goes, if you don’t know who you are, the stock market is a very expensive place to learn.

What does that mean? It isn’t terribly complicated. Let’s look at two aspects of it.

First, you should know your expectations, your goals and what you need from your investments. Are you more interested in beating the market (being competitive, in other words), or in obtaining a specific return with the lowest level of risk? (And if you want a specific return, what exactly do you need?)

Second, and crucial during volatile market conditions, you should know how much risk you are willing and able to stomach. In plain English, that means you should know about how much money (or what percent of your portfolio) you are willing to lose and still stay in the game.

Over the years I have dealt with many “fair-weather investors” who are full of hope and confidence at the start but who panic and bail out at the slightest adversity. This behavior is frustrating and counterproductive — not to mention potentially very expensive.

In order to know your expectations, goals and needs, you must spend some time thinking and perhaps studying. The same is true of understanding your risk tolerance.

The best way to become clear on these points is with the help of a financial adviser. Short of that, you’ll find a lot of good guidance in my 2011 book “Financial Fitness Forever.”

To figure out the relationship between risk and return in the stock and bond markets, I suggest an article I wrote earlier this year.

None of this directly addresses the pressing practical question of the moment for many investors: How do I get back into the market during these volatile times.

The bad news is that there’s no answer to that question that’s even close to perfect. The good news is that you don’t need a perfect answer.

You can get back into the market if you’re willing to know yourself, make a good plan and bring some helpful attributes to the table. Those attributes include reasonable expectations, patience. And you’ve got to be willing to stop thinking that every up and down in the market is vitally important.

Are you thinking about getting back in right now?

Don’t do so until you have taken a thoughtful timeout to get to know yourself a bit better. Otherwise, sooner or later you’ll most likely find yourself in the very same dilemma.

When you’re ready, you can get back in with dollar-cost averaging or all at once in a lump sum. The precise method you use is much less important than how well you know yourself.

Richard Buck contributed to this article.