Investing Tips for a Volatile Market

Advice for investors who have lost confidence in the integrity of the system and are considering dumping stocks.

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I can’t blame you if you are spooked by today’s investing climate. Memories of the May 6, 2010, “flash crash” were just starting to fade. As I am sure you will recall, on that fateful day, the Dow Jones Industrial Average dropped by an astounding 1000 points (initially) in 16 minutes. According to the New York Times, almost a trillion dollars of value disappeared. Stocks of major blue-chip companies traded for a fraction of their value. Accenture fell to a penny a share. Proctor & Gamble dropped from $60 to $39.37 in minutes.

Just when you thought it was safe to get in the water, it seems like the sharks came out in full force. Knight Capital, a big market maker (it generated 11 percent of all the trades in the first half of this year), lost $440 million (and possibly more) in less than an a hour from a “computer-trading glitch.”

These events, coupled with the slow recovery in the United States and a deepening economic crisis in Europe, have left investors dazed and confused.

The news was not all bad, which makes it even more difficult to decipher what is really going on. According to a blog by Weston Wellington of Dimensional Fund Advisors, the stocks of a large number of major companies hit 52-week highs and the S&P 500 Index reached its highest level in three months on August 3, 2012.

Many investors have lost confidence in the integrity of the system (and its reliability!) and are considering dumping their retail stocks. A column in the Wall Street Journal by Jason Zweig notes that more than $129 billion has exited stock funds in the 12 months ending in June 2012, according to Morningstar. Should you join the stampede?

You have plenty of encouragement to do so. Prominent investors like Bill Gross, the “King of Bonds,” who runs PIMCO, recently proclaimed that “the cult of equity is dying.”

Here’s my investing tip for those of you who feel panicked and inclined to dump your stocks. Don’t do it.

Short-term gyrations in the market impact traders. They have little effect on long-term investors. When you look at long-term data over the past decade (one that is generally regarded as a terrible one for stocks), you can see the benefits of buying and holding a globally diversified portfolio of low-cost stock and bond index funds in a suitable asset allocation.

I reviewed the returns of a portfolio offered by Index Funds Advisors (with whom I am affiliated) for the 10 year and 7 month period from Jan. 1, 2002, to July 31, 2012. This portfolio is allocated 60 percent to stocks and 40 percent to bonds, which is a very common asset allocation for those who can accept a moderate amount of risk. It had an annualized return of 6.16 percent during this period: $100,000 invested on Jan. 1, 2002, grew to $188,282.73 on July 31, 2012.

Jack Bogle, the venerable co-founder of Vanguard, had these observations about the market in an interview published August 11, 2012, in the New York Times: “Wise investors won’t try to outsmart the market …They’ll buy index funds for the long term, and they’ll diversify.”

Bogle’s sage advice should be followed by all investors. Ignore the hype and predictions by those who believe they have psychic powers. Determine your asset allocation. Buy low-management-fee stock and bond funds. Watch the financial media if you find it entertaining. With notable exceptions, it is often not a source of reliable investing advice.

Dan Solin is a senior vice president of Index Funds Advisors. He is the New York Times bestselling author of The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read, and The Smartest Portfolio You'll Ever Own. His new book, The Smartest Money Book You'll Ever Read, was published on December 27, 2011.

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