We'd all know exactly how to react if we had that mythical crystal ball. We don't. But we do have years of stock market history to tell us most of what we need to know about the mindset we need to adopt in 2008.
2007: The Tale of Two Markets
The first half of 2007 trended up and had some of the lowest volatility in history.
· The S&P 500 went from early March through late July without a 2% correction.• Unheard of when considering more than a 2% decline during just two combined trading days, the last day in 2007 and the first day of 2008!
The second half of 2007 was almost the opposite. It was marked by much higher than normal volatility and a stock market decline. The increased volatility was predictable based on past history.
· Markets with low volatility are almost always followed by higher than normal volatility. Markets are supposed to fluctuate. When they don't fluctuate most investors become complacent.
· Low market volatility tends to cause investors to overlook risk and risk management in pursuit of higher returns.
· The result is generally an increase in volatility and a drop in the market.
So what does all this mean for investors in 2008? What should your mindset become?
1) Don't get caught up in the Wall Street and the financial media's short-term performance myth. Wall Street tends to put too much emphasis on short-term performance. That is generally how they sell their products. Mark cycles are much longer than most people think.
2) Remember good performance requires strong investment discipline and time. We invest to make money not to lose it. The key is to define what exactly constitutes good or great performance. Ask yourself this question: Do I want the best short-term performance or the best life-long performance? The answer to this question will send you in almost opposite directions.
3) The best way to achieve success in a volatile market: hire an investment manager who uses tools and methods to manage risk and protect your portfolio from high volatility and the inevitable downturns. Anyone can make money when the market goes up. But how are you or your manager doing when trying to avoid large drops in your portfolio during difficult market cycles?