Strategies for Volatile Markets 8/26/07
Stewart H. Welch III, CFP, AEP
Founder, The Welch Group, LLC
Strategies for Volatile Markets
“Strategies for Volatile Markets”
Since its July 19 peak, the stock market has experienced record volatility on a daily basis. We’ve seen days where the market has moved over 400 points. It has been up significantly one day, down significantly the next. After gyrating for almost a month, it finally crossed the negative 10% mark, signaling a technical market correction. All of this has been driven by the debacle of the sub-prime mortgage business. Essentially what happened: there was an abundance of liquidity which spurred an unabated inflow of new mortgage lenders who offered just about anyone who could ‘fog a mirror’ 100% financing to buy a home. People jumped at the opportunity to buy a home for little or nothing down, in many cases accepting interest-only or adjustable rate mortgage plans. Rising interest rates has caused the whole house of cards to tumble and to spread to more traditional mortgage financing as well as the financial markets in general. How serious is this problem and what’s the impact on investors?
The problem is very serious as indicated by the steps taken by the Federal Reserve and central banks around the world, pumping billions of dollars into the banking systems to provide the liquidity needed to avoid a real credit crisis. It is impossible to say if the worst is behind us or ahead of us. Just this past week, Capital One, a major banking and mortgage lending institution, announced plans to close its mortgage operations which spanned nineteen states and employed 1900 people. I am convinced that our government will do all that is in their power to maintain stability in our banking and lending system. Whether the government will offer a lending hand to the thousands of families that face foreclosure is another question.
As investors, it may be time to revisit the tried and true rules of investing that have been around for decades… with maybe a bit of a twist. First, I recommend that you divide your investments into three broad ‘pots’.
Core holdings. Two of the pots will be part of your core which will focus on high quality, long-term investments. One pot consists of high quality bonds or bond mutual funds. If you are more than 10 years away from retirement, I typically recommend that your allocation be between 0% and 20%. As you move closer to retirement, consider increasing this allocation to as much as 50%. The second pot will be high quality stocks or stock mutual funds. I favor large blue chip stocks of companies which have a history of paying and raising their dividends consistently over time. Be sure to diversify your holdings across a number of stocks and industries.
Explore holdings. For your third pot, put a set percentage or dollar amount of your portfolio into investments where you feel there is greater opportunity (and higher risks). Depending on your appetite for risks, you may consider allocating between 0% and 30% to this category.
The key to success is to limit the more aggressive part of your investing so that when the markets display significant negative volatility, as they have over the past several weeks, you won’t feel a sense of panic and will be more willing to wait out the storm even if it takes several months or longer.