"It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness...we had everything before us, we had nothing before us ..." -- Charles Dickens, A Tale of Two Cities.
This is indeed the best of times and the worst of times for investors long in the stock market. For many of us who opened new positions right before the market crashed, we're now underwater in a big way. Those who were already sitting on hefty gains have seen their gains downsized, if not completely wiped out. And those holdings that were already a paper loss are now drowning in a sea of red. However, with great challenge comes great opportunity, and there are many quality companies now selling for bargain basement prices on the market, waiting for investors bold enough to dive headfirst into the carnage.
In volatile times like these, where the index can be up 5% one day and down 5% the next, it's important to tune out the noise. If the whipsaw market has taught us anything, it's that now, more than ever, the fundamentals matter. Remember that for every expert or analyst who's dispensing advice on what you should do, there's someone else out there with the same credentials who's recommending the exact opposite. And yes, that means you should take this with a grain of salt, too. In the end, you just have to trust in yourself, your research and your portfolio. The wild convulsions that the market is going through right now will make your head spin if you stare at it for too long, so forget about the market and return to the basics. Here are a few time-tested tips and tricks you can use to navigate this crisis and emerge on the other side unscathed.
Use limit orders. Investors typically set up limit orders when they don't have time to track the market day by day. But limit orders have a second useful function: Their mechanical nature helps to clean out the emotional detritus that likes to latch on to our investment decisions. If you're looking to initiate a new position, establish a target, set a buy limit and walk away. If you want to double down on a current holding, figure out how much of a drop you want to see before you inject more capital into your position, then set a limit order to meet that criterion. Resist the temptation to revise your orders upwards or downwards if the market moves in a direction you didn't anticipate. If you do that, you'll end up perpetually chasing a carrot that's forever out of reach.
To bring this idea back home, I bought Berkshire Hathaway (NYSE:BRK.B) at $75 last month. I had been keeping a large stash of cash in reserve before the market took a nosedive, and this was a position that I wanted to double down on. Was I tempted to get in before it was too late on Tuesday, when Berkshire began to rally big time? Of course, but I set a rule for myself that I would only infuse an existing position with more capital if it dropped at least 10% below my purchase price. So I set a limit order to buy more Berkshire at $67 even though it ended the day at $72. Lo and behold, the order got filled the next afternoon. At the time of this writing, the stock's swung back to $72.
Don't be afraid to rebalance your portfolio. This can include selling out an existing position and dumping the cash into a new one. Investors in general are psychologically inhibited against closing out a losing position and admitting defeat, but sometimes that's a necessary move to capitalize on an even better opportunity that just came into play.
All of us have a wish list of stocks that we would love to snap up when the price is right. The market may have fallen as a whole, but some stocks crashed a lot harder than others. For example, financials like Bank of America (NYSE:BAC) and Wells Fargo (NYSE:WFC) took it on the chin harder than almost every other sector. On the flip side, some stocks barely even dipped during this entire market plunge, like McDonald's (NYSE:MCD) and mortgage REIT Annaly Capital Management (NYSE:NLY). Revisit your wish list and compare it to your current holdings. Due to the heavy reshuffling that's transpired as a result of the crash, some of the stocks on your wish list may be even better deals now than stocks in your portfolio. Don't be afraid to reallocate your capital and put yourself in the best possible position to ride an updraft in the market.
Don't underestimate yield. A 10-year treasury bond is currently yielding 2.3%. In the meantime, you can buy into stable, high quality blue chips like Procter & Gamble (NYSE:PG) and Philip Morris (NYSE:PM) and bag yields of 3.5% and 3.8%, respectively. When market values fall, yields always go up. What makes these companies even better deals is that they tend to increase their dividends over time. Procter & Gamble raised its dividend payout by almost 200% over the past decade. It's not hard to see why current market conditions present a wonderful opportunity for dividend investors who are engineering their portfolios to generate a steady, reliable income stream rather than achieve capital appreciation.
Beware the dangers of margin. A margin account can be a useful tool in your utility belt, but the leverage system for stocks is structured to be a lot less advantageous for the borrower than, say, the leverage system for real estate. After all, the bank isn't going to foreclose on your house if its market value drops. Margin calls are the furthest things from our minds when the market is shooting to the moon, but when a huge correction like this one hits, suddenly all the brokers come calling at once. Just like we look for companies with clean balance sheets, we want our own personal balance sheets to be clean, too. That means employing debt wisely, and most of the time that means sparingly. If you're going to dip into your margin funds, be aware that some brokers have higher maintenance requirements for different stocks and asset classes. Stocks with low face values like Level 3 Communications (NASDAQ:LVLT) tend to operate under a different rule set inside a margin account. Leveraged ETFs like the Direxion Financial Bull (NYSEARCA:FAS) and the Direxion Small Cap Bull (NYSEARCA:TNA) usually demand higher maintenance requirements as well.
When it comes down to it, the most important thing to do right now is to stay true to your investment principles. Erratic market movements like these tend to bring out the speculator tucked away inside all of us. Don't listen to that guy. Formulate a battle plan and stick to it. Consistency is the key that'll carry your portfolio through this madness. Hopefully when it's all over, we'll all be able to look back and say, "Hey, that was a great opportunity to make some money, and I got in on a piece of the action."
Disclosure: I am long BRK.B.