The market is going down, up, down again ... and maybe sideways for a little while. What should you do?
Everyone’s financial situation and tolerance for risk is different. What may be good advice for a 21-year-old may not be the best course of action for a 65-year-old. Some investors may be able to afford a little risk in their portfolio ... others not. And while some folks may be able to muddle through, others may need a professional financial adviser to sort out their situation.
But there are some basic things all investors should keep in mind ...
Diversification: You’ve heard the expression “Don’t put all your eggs in one basket.” The same holds true for portfolios. If all your investments are in the same category, and that category takes a hit, you’ll take all the damage. If your investments are spread out over different categories, then a big hit in one only means a little damage to you. For that reason, many investors divide up their holdings between stocks, bonds, and other types of investments. And they often carry the strategy even further, divvying up stock holdings between large companies and small companies, for example. (Check out CNBC stock guru Jim Cramer’s take on diversification.)
Asset allocation: So if you want to diversify, how do you do it? That basically depends on your age and your appetite for risk. Generally, the older you are, the less risk you want to have in your portfolio, since a loss will be harder to make up over time. So older folks may want more bond holdings in their portfolio, since bonds are considered less risky than stocks for the most part, and/or relatively low-risk, high-yielding dividend stocks. On the other hand, younger investors may be willing to take on more risk, as so may want a greater percentage of stocks in the holdings in hopes of greater gains over time. Other investments, like commodities and real estate, may also enter into consideration, although professionals often differ about the relative safety of these types of investments. (Watch a discussion of asset allocation here.)
Dollar Cost Averaging: Many investors purchase stocks and other investments at regular intervals in fixed dollar amounts. This tends to reduce the volatility in their portfolios, regardless of what direction the market is moving, because as prices of securities rise, fewer units are bought, and vice versa. (Read more hereandlisten to Blackrock’s Bob Doll discuss it here.) In certain markets, however, some traders ... usually those with shorter time horizons ... argue against such strategies. (You can hear one such argument here.)
You can delve deeper into these terms and other financial lingo in our glossary. In addition, you can learn more about investing basics at our Investor Center and some of the larger economic concepts and market fundamentals at play in CNBC Explains.
The Next Level
Now, for some savvy investors, market downturns mean opportunity ... a chance to buy stocks with good potential for growth at bargain prices. This is where research and strategy come into play. And learning about the nuts and bolts, such as ...
- Knowing the difference between a market order and a stop order.
- Knowing the difference between growth stocks and value stocks.
- Understanding the metrics of the market, like P/E ratios andBeta.
And beyond that, there’s a whole range of strategies and theories ... from chart patterns to short squeezes to option straddles. CNBC’s trading program “Fast Money” has a whole “trade school” devoted to these subjects. And, of course, Jim Cramer discusses stock investing regularly on his show, “Mad Money.”
Of course, some people prefer to have professional financial advisers handle the sophisticated matters. There, too, are some individual things to consider.
No matter where you are in terms of investment knowledge, investors all agree on one thing ... don’t panic.
This story, originally published in February 2008, has been updated periodically.