The Smarter Investor

What to Do When the Market Tanks

August 10, 2011 RSS Feed Print

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Kelly Campbell

Wow, what a ride last week. Unfortunately, things are not going to get better any time soon. So, now is the time to have a plan. Here are three things you should do to survive a significant market correction:

Do not panic. Making decisions in the heat of the moment is always a bad idea. Think about the market after 9/11. The Dow Jones Industrial Average decreased by 2,000 points almost immediately, resulting in a significant downturn that lasted about three months. It bounced around for a short period only to return to its pre-9/11 numbers within three months. Therefore, rash decisions can be calamitous when a market is so unpredictable.

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Get your financial house in order. The Dow dropping 600 points in one day is enough to scare anyone. But if you have a financial plan, you'll know where you stand. You will also know what that market change means to your situation instead of just thinking the worst. Remember, knowledge is power.

Consider the downturn of 2008 when the Dow made one- and two-hundred point changes almost daily. I look back to those times and remember talking to a number of clients who were extremely worried about the market. But since we had a financial plan for all of our clients, it was easy to show them the exact impact through their plan. It typically turned out that they were in good shape.

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My guess is that most people are not in financial dire straights after last week. Most simply do not know where they stand. Putting together a financial plan that looks at net worth, cash flow, retirement, education funding (if you have kids), and even life insurance is the key to your comfort.

Have an investment management plan. Thinking through what you'll do if the market has significant swings can help you get through a period of uncertainty. We have significant diversity among asset classes that do not rely too heavily on any one area of the market. This helps our portfolio weather the storm of a downturn.

For example, several investments in our portfolios have responded quite well to the markets of the last few weeks. We use these investments to keep risk levels low. Things that have done well in this market include managed futures, absolute return funds, and quantitative analysis funds. These alternative investment strategies do not participate in the typical market gyrations, and can significantly lower the overall risk of your portfolio. You need to know about them and have them in your investment management plan.

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These are just a few things you can do to be ready for the next round of storms, instead of just sitting around watching your portfolio drop. But, be prepared to think a little differently and not follow the herd.

Good luck and happy investing.

Kelly Campbell, CFP® and Accredited Investment Fiduciary, is founder of Campbell Wealth Management, a Registered Investment Advisor in Alexandria, Va. Campbell is also the author of Fire Your Broker, a controversial look at the broker industry written as an empathetic response to the trials and tribulations many investors have faced as the stock market cratered and their advisers abandoned their responsibilities to help them weather the storm.

Tags:: investing,; mutual funds,; stock market

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Why are they pushing managed futures and other inverse strategies *after* a huge drop in the market, when the easy money has already been made? Because the really easy money is in those undisclosed commission rates, along with the CTA’s management and incentive fees. That would also explain the variable annuity in your grandmother's IRA.
Thanks for reaching out!

Lauren Bacall of NY 3:07AM August 14, 2011

The problem with absolute-return funds is not just how they are being sold, but how they work — or fail to — for the typical investor.
Absolute-return strategies purport to produce a positive return in all market conditions, no matter the direction of the market. They typically try to do this by investing some of the portfolio in cash or low-volatility investments, and then taking long and short positions that, when combined, should deliver results that don’t really correlate to what’s happening in the broad market.
In plain English, that means they buy stocks they expect to go up, and sell short stocks they expect to go down (shorting a stock involves borrowing shares from a brokerage firm, selling them and hoping the price will drop; the shares can then be repurchased at a lower price, returned to the brokerage and the investor pockets the difference).
The average investor couldn’t explain this strategy; what they hear is that they get an “absolute return,” which they take to mean a steady gain under all market conditions, something safe and secure, like a long-term certificate of deposit paying an oversized yield. Absolute-return funds come in different flavors — some are more focused on bonds, some in certain sectors or geographic regions — but the underlying idea is the same.
In fact, investors tend to worry more about “relative returns” rather than absolute ones. For example, the average fund with the words “absolute return” in its name was up 3.34% in 2010, according to Morningstar Inc., compared to the 15% return from the Standard & Poor’s 500-stock index SPX +0.53% . The gap was bigger in 2009, when the average absolute-return issue gained 10.7% but the index was up 26.5%.
While the funds did their job in a down market, they still posted losses — which hardly seems an “absolute return” — and the typical investor would have walked away from that experience feeling let down by the fund.
Long-short strategies work best when stocks are not running like a herd, all going in the same direction as the market. They need a differentiation between strong and weak stocks, so rallies or declines that occur without regard to financial fundamentals tend to leave the strategy in the dust. That’s why the funds may have looked all right compared to the market in 2008, but investors should have expected better, and it explains the big lag in 2009.
Even if you believe that a true absolute-return strategy can be executed, in truth there aren’t many managers who would be able to do it successfully. Yet the fund business keeps churning out new absolute-return issues, some using the label, others tagged only as “long-short” funds. What’s more, if the strategy works, it will still be disappointing enough of the time so that most investors will not be able to stick with it.

TJ of NY 10:41AM August 13, 2011

Bob of CA,
Managed futures are not the roulette wheel you paint them to be.
First, let's talk about programs disappearing. The Nasdaq has a turnover of about 5% of their listings each year, and in times of economic turmoil, even more companies are delisted. In 2008, more companies were delisted from the NYSE than ever before. I don't hear you complaining about that...
That's also why due diligence is important- and this answers your point about indices as well, because most investors don't invest in a managed futures index- they invest in programs. If you work through a managed futures broker (or at least a good one), they're constantly monitoring the programs you invest in to keep tabs on their performance and advise you on entry and exit points.
Your understanding of the fees is also out of whack. If you're looking at performance without fees included, you're not looking in the right place. (Here are a few comments on fee issues: http://www.attaincapital.com/alternative-investment-education/managed-futures-newsletter/investment_trading_education/427)
Performance is reported net of fees here: http://www.attaincapital.com/alternative-investment-performance/managed-futures/recommended-ctas/page1). While past performance is not necessarily indicative of future results, the data is impressive nonetheless.
That being said, this information does assume you're discussing managed accounts- not managed futures mutual funds or ETFs, which are an entirely different story.
Managed futures are non-correlated with the stock market, making them excellent portfolio diversifiers for qualified investors. And again, while past performance is not necessarily indicative of future results, managed futures, again and again, have demonstrated exemplary crisis period performance- see here: http://www.attaincapital.com/alternative-investment-education/managed-futures-newsletter/investment-trading-education/417
If you have any further questions on the matter, please don't hesitate to reach out!
Disclaimer: Managed futures and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. This comment is for informational purposes only. It is not intended as investment advice, or an offer or solicitation for the purchase or sale of any financial instrument.

Lauren Nelson of IL 11:06AM August 12, 2011