When giants fall, how can the average person resist getting caught in the financial crisis?
The markets are reeling from the recent news that Bank of America acquired Merrill Lynch, a 94-year-old institution that was one of the last remaining independent holdouts on the street, while at the same time the 158-year-old securities firm Lehman Brothers has filed for bankruptcy protection. And the bad news doesn’t stop there. American International Group (A.I.G.), still woozy from the credit crisis joined troubled mortgage finance companies Fannie Mae and Freddie Mac in receiving a bailout from the Federal Government. The Dow dropped 449 points on the news of the AIG bailout. And shares in the last two independent investment banks, Morgan Stanley and Goldman Sachs fell precipitously on fears that they might go the way of Lehman and Merrill.
Coming on the heels of the forced sale of Bear Stearns to JPMorgan Chase earlier this year, its more than enough to make the average person wonder if our entire economy is on the verge of collapse. When such seemingly solvent financial institutions get shaken to their foundations, it leaves a lot of rubble.
So what can you do to make sure you are protected?
Resist the tendency to respond emotionally. The Three Principles of Personal Finance haven’t changed just because Lehman Brothers made some poor financial decisions. Stick with the three principles and you will be prepared for any crisis.
- Spend less than you earn
- Make the money you have work for you
- Be prepared for the unexpected
Don’t try to time the market
Dollar cost average your way into the market instead. Dollar cost averaging is an investing approach that reduces exposure to the risk associated with making a single large purchase. Spend a fixed dollar amount at regular intervals on a particular investment regardless of the share price. More shares are purchased when prices are low and fewer when prices are high.
By following the most basic investing principle, “buy low, sell high,” you can turn the market volatility to your advantage and lower your average cost basis. This means higher returns when the market eventually rebounds.
Take a long-term approach and keep making regular, steady investments into your 401k & IRA. Bull and bear markets cycle through every few years. Many investors saw a growth in their portfolios in the 90’s only to see their profits dissolve by 2002. But the ones that panicked, abandoned the stock market, and put what was left of their remaining assets into low-yield CDs were not well positioned for the rebound that occurred between 2003-2006. Keep this simple fact in mind. According to Jeremy J. Siegel, there is not a single 20-year-period in the last 100 years where the stock market has not increased in value*
Still worried? See if your employer offers dollar-for-dollar 401k contribution matching. That’s like getting an instant 100% return.
While consumer financial services are down 54% over the past year, healthcare has outperformed the S&P 500 by 10% – just a few years ago, the situation was reversed. Rather than investing in a single stock or single sector of the economy, look for mutual funds that invest across many businesses. Another option, index funds, which are less subject to seismic shifts in the market because they are based on a set of rules of ownership that remain constant, regardless of market conditions.
Remember these principles when making investment decisions and you can rise from the rubble.
* Stocks for the Long Run, by Jeremy J. Siegel, McGraw-Hill Companies; 4nd edition (November 27, 2007, ISBN 9780071494700)