I pulled this off of fidelity's site today. A must read for everyone. It is titled Common sense for principles of mutual fund investing, but I believe on should use it in any form of investing.
Cheers
RG
Common sense principles of mutual fund investing
The best way to prepare for down markets is to apply common sense investing
principles before making responsible investments ? those based on reliable
information. The following section offers some suggestions for every level of
investor.
Know yourself
Think about the money that you're investing and its intended use. Think about
your financial situation ? stability in your job, your debt level, whether your spouse
or partner intends to stop working soon. The ability to properly assess these areas
will make you a better investor as you think about your range of options.
Match investments to your comfort level
As Peter Lynch says, "The key organ [to stock investing] isn't the brain, it's the
stomach." Even if your time horizon is long enough to have an aggressive growth
portfolio, you need to make sure you're comfortable with the short-term
fluctuations you'll encounter. If watching your assets fluctuate is too
uncomfortable for you, think about a portfolio that feels right.
*Average of years where return is negative.
Source:¸ Stocks, Bonds, Bills, and Inflation 1998 YearbookTM, Ibbotson Associates,
Chicago (annually updates work by Roger G. Ibbotson and Rex A. Sinquefield). Used with
permission. All rights reserved. These portfolios are meant only to illustrate historical
performance and should not be construed as recommendations for your own portfolio.
Remember, past performance is no guarantee of future results. In making your own asset
allocation decisions, you should consider your goal, risk tolerance, and time horizon.
Based on calendar year returns.
Diversify, diversify, diversify
One way to protect yourself from unpredictable market downturns is to diversify
your holdings. Most investors use an asset allocation strategy in designing their
portfolios. Decide in advance how much of your assets you want in short-term
investments, how much in bonds, and how much you want in stocks. By dividing
your total portfolio among the three asset classes, you can lower your exposure to
the risks associated with having all your investments in one class.
You can also diversify within an asset class by investing in different types of
securities within that class. For example, instead of putting all your stock
investment allocation into a single moderate-risk stock fund, you might put some in
a large-capitalization fund and some in a fund that invests in small-cap stocks.
Other investors include international funds in their investment mix, because
foreign countries often follow different economic cycles than the U.S.
In bonds, you may want to try "laddering" or investing in bonds with a range of
maturities so that funds become available for reinvestment periodically. If rates
rise, laddering also helps avoid having all your money locked into a fixed yield for
a set number of years. As bonds mature, you can reinvest your maturing bonds at
higher rates. If rates fall, you'll have some protection from that portion of your
portfolio that's already invested at higher rates.
Invest for the long term
With experience, most investors come to know that volatility decreases over time.
Holding a stock for 20 years reduces its volatility by two-thirds, as compared with
keeping a stock in your portfolio for only one year. Volatility doesn't necessarily
measure performance ? a volatile investment may perform well or poorly, but it
does indicate how much the performance varied along the way. As a long-term
investor, you want to focus on longer trends, not temporary fluctuations. The key
is to maintain your long-term investment goals. Thinking long term can help calm
fears generated by short-term market fluctuations.
This chart illustrates that, historically, the returns for various asset classes,
particularly stocks, became significantly less volatile when held for longer periods.
Source: Stocks, Bonds, Bills, and Inflation 1998 YearbookTM, Ibbotson Associates,
Chicago (annually updates work by Roger C. Ibbotson and Rex A. Sinquefield). Used with
permission. All rights reserved. This chart is a graphic representation of the historical
annual, rolling 5-year period, rolling 10-year period, and rolling 20-year period returns for the
S&P 500©, long-term government bonds, and U.S. Treasury bills for the period 1926-1998.
Long-term government bonds (representing higher-yielding, long-term government
securities), represented by the Salomon Brothers Long-Term Government Bond Index,
common stocks as measured by the S&P 500, and Treasury bills as measured by 30-day
Treasury bills. Past performance is no guarantee of future results. Unlike common stocks,
government-issued securities offer a fixed rate of return and guarantee principal if held to
maturity. The indices are unmanaged and include dividend reinvestment for the S&P 500.
Not intended to imply future performance of any Fidelity fund.
The Standard & Poor?s 500 Index is a widely recognized, unmanaged index of common
stocks.
Based on calendar year.
Don't try to time the market
Even experts cannot predict the market with any degree of consistency. Yet many
investors think they can divine what will happen based on hunches or rumors.
Pulling out of stocks or bonds in anticipation of a market decline is one common
form of market-timing behavior. So is holding off on investing until the market
"settles down." But timing the market requires two things: knowing the right time to
buy and the right time to sell. If you miss either, you can miss the market. Most of
the market's gains occur in just a few strong, but unpredictable, trading days here
and there. To maximize the market's long-term performance, you have to be in the
market on those days.
The key to surviving in a rapidly changing market environment is to identify your
final destination, chart a course to reach it, and then stay the course. If based on
research, you've determined that you're in the right investments, responsible
investing dictates that you stay with them. Riding out the storms is often the
hardest thing to do, but it is the key to reaching your long-term goals.
This chart shows that from 1990 through September of 1999, if you were out of stocks for
the 10 best months of the market, your return would have been only slightly greater than if
you had been in Treasuries.
This chart is based on historical monthly returns of the S&P 500©and U.S. Treasury bills for
the period 1/1/90-9/30/99, and includes reinvestment of dividends and capital gains. T-Bills
based on the Solomon Brothers 3-month T-Bill. This example does not represent the
performance of any particular investment.
Invest regularly
If you believe that timing the market accurately is next to impossible, the best
strategy may be to invest a specific amount of money monthly or quarterly,
regardless of market conditions. While this can't protect you from a loss in a
declining market and won't guarantee a profit, over time it should help to lower the
average cost of your investment purchases. Investing regularly can also help you
maintain a proper perspective on market volatility, while providing an effective
strategy for building wealth.
Think about the tax consequences of selling
The last decade has produced some extraordinary appreciation in holdings.
Investors who are wary of the market and considering wholesale liquidation of
their portfolios should realize that the tax consequences might be considerable.
While some funds declare some capital gains each year, investors are still
responsible for the appreciation when they sell. Any capital gains on shares held
one year or less are taxed by the federal government at the same rate as ordinary
income - from 15% to 39.6%. Capital gains realized on shares held for more than
one year are subject to federal taxes at 10% if you're in the 15% tax bracket or
20% if you're in the 28% bracket or higher. Making a hasty decision to forsake
your stock or bond holdings in a market downturn could result in a higher tax bill.
Set realistic expectations for returns
During the past 10 years, domestic stock returns have increased an average of
12% per year. However, from 1995-1998, the S&P 500© has been up over 20%
each year. This unusually high return has skewed some investor expectations
about investing in stocks.
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