The stock market plunge has whiplashed many investors and left them wondering what to do about their portfolios.
Don't panic. Instead you want to think about the three D's, says Erik Davidson, a chartered financial analyst and senior director of investments at Wells Fargo Private Bank in Denver.
The first D - employing a defensive strategy - could lead you to make a mistake, Davidson said. "The big question out there from investors is, 'Is it time to get defensive with my portfolio?' " he said.
And by that they mean: Should they sell off everything and head for safer ground such as CDs, treasury bonds, or money market accounts?
Davidson advises that in the current market environment, the two other D's are more important.
Let's look at that second D - diversification. If you are investing through your employer's retirement plan, such as a 401(k), go online to view your portfolio or get your last quarterly statement. Look at where and how you've allocated your money. Is it spread across various asset classes? Or have you concentrated your contributions in just one or two types of asset categories? In other words, is your money all in one basket?
Some people who put all or most of their money in real estate or mortgage-backed securities are taking a well-deserved whipping right now. They ignored the nine most important words in investing - "Past performance is not a guarantee of future results," Davidson said.
If you have a diversified portfolio, you don't have to be fearful of current events, says Jeff Seely, chief executive of ShareBuilder, an online brokerage that caters to small investors and is designed for long-term investing.
"Recently, there has been a lot of volatility, with 200 to 300 point up days followed by equal-magnitude down days," Seely points out. "Small investors absolutely get stressed when the market is unstable, particularly after a sustained period of good performance."
But if you select good fundamental stocks, or broad exchange-traded funds, those should produce gains longer term, and a downturn is when to buy, he said.
Davidson said if you want to avoid reaching for antacid during times like this, divide your investment contributions so that a certain percentage is invested in a variety of assets, such as large-cap or large, blue-chip stocks. You should have some money in mid-cap and small-cap stocks (medium- and small-size companies). Put a percentage in real estate and international securities, and in fixed income securities, such as bonds.
"I think it's safe to say every investor no matter [his or her] risk tolerance should have some exposure to all the major asset classes," Davidson said.
How much you put into each category depends on how much risk you can stand. If you're investing in an employer-sponsored retirement plan and you're unsure how to allocate your contributions, contact the firm that manages the plan. Often it can help you develop an asset-allocation plan based on your risk tolerance and your investment time horizon.
The third D - discipline. Once you develop a plan or asset-allocation approach, you've got to stick to it.
Let's say you decided you only wanted to invest 20 percent of your 401(k) contributions in a real estate investment trust, which is a security that sells like a stock and invests either directly in properties or in real estate-related loans, such as mortgages. During the run-up in the real estate market, your investment may have grown to 40 percent of your portfolio. Although that's great, you may want to rebalance.
"The market can put target asset allocation out of whack," Davidson said. "A good rule of thumb is that if an asset class has gotten more than 10 percent away from your original allocation, you should reallocate."
If you want to avoid making investment decisions based on your emotions, consider a dollar-cost averaging investment strategy, Seely says. Using this method invests the same dollar amount at regular intervals regardless of a fund or stock's price as a way to ride out volatility.
Whatever you do, "have a programmed approach that keeps you buying during the downturns," Seely said. "Think about something other than what the market did today."
Michelle Singletary is a columnist for The Washington Post. She can be reached at singletarym@washpost.com.
