3 Things Investors Should Do Now

by: Investment U

First it was Countrywide. Then it was Bear Stearns. Then Freddie (FRE) and Fannie (FNM). Now we learn that Lehman Brothers (LEH) has filed for Chapter 11. 

Bank of America (NYSE:BAC) bought the nation's largest brokerage firm Merrill Lynch (MER), in a rush sale. 

One of the nation's biggest insurers AIG (NYSE:AIG) is seeking a $40 billion bridge loan from the Federal Reserve and slumped 50% Monday morning. (After dropping over 30% on Friday.)

Predictably, the market is taking this news hard. As an investor in the midst of this Wall Street meltdown, what should you do now?

Well, you can panic and sell. (That hasn't been terribly productive in the past.) Or you stick with your discipline - provided it is a good one.

For years we have been beating the drum for the fundamental principles of investing: Buy quality. Diversify broadly. Asset allocate properly. And think long term.

Let's take a closer look at each of these…

Though Stocks Are Down, There Are Still Great Companies Available

It's true that stocks of all stripes are down, both here and abroad. But if you own great companies, they will recover when this storm passes.

It's been almost exactly 10 years since another major financial crisis hit world markets. Russia defaulted on its sovereign debt, something once unthinkable. (Yields on ruble-denominated debt soared to more than 200%.) That set off a chain reaction in world debt markets that caused the collapse of hedge fund giant Long-Term Capital.

For a while there was chaos in world markets. But you know what? Most of us survived. And, after a while, the world went on about its business. 

Today that crisis seems like nothing more than a blip on the charts.

Personally, I think the current credit crisis is going to be more stubborn, more persistent. Because the problems they face are more widespread. They stem from deep-seated problems in the nation's real estate and mortgage markets. (The deflating of a massive bubble.)

This situation is simply going to have to play out. Some homeowners are going to become renters. Some bankers, realtors and mortgage brokers are going to become bartenders. 

But, in the end, the underlying strength of the American economy will prevail. Just as it always has in the past: Through financial crises, war, inflation, recession and depression.

That doesn't mean that things aren't going to get worse before they get better. But as I've said in this column many times, you shouldn't have money in the stock market that you need in less than five years.

If you do, you are a trader. Not an investor. 

Diversify Your Portfolio Through Asset Allocation

A long-term investor diversifies beyond traditional stocks. Our Oxford Asset Allocation Model, for example, suggests that you should not have more than 60% of your total portfolio in equities.

You should have 10% in investment grade bonds, which are up today. You should have 10% in inflation-adjusted Treasuries, which are up today. You should have at least 5% in gold shares, which are up today. 

You asset allocate to reduce your portfolio's volatility and protect your capital in difficult times like these.

Your worst enemy right now is not likely to be the market but your emotions. Deeply ingrained instincts prompt us to "do something" when we feel threatened or nervous. But strong emotions are often the prelude to bad decision-making.

The Gone Fishin' Portfolio & Long-Term Success

In my new book "The Gone Fishin' Portfolio," I put forward a plan that offers a high probability of long-term success. But I concede that the ultimate outcome depends on the investor himself. 

That's why I included an entire chapter on managing your expectations and dealing effectively with the psychological hurdles the market throws in your way from time to time… as it is now. 

  • First off, do a reality check. Recognize that investing in stocks means your account value is bound to sustain wide fluctuations from time to time. 

  • It's unrealistic to think that you're going to earn the superior returns only stocks can give while watching your account rise as smoothly as a savings account. (Investors who think this way are expecting what never was and what never will be.)

  • I also show you how to automate your investments and invest unemotionally, regardless of how you may feel. As Warren Buffett said of he and his partner Charlie Munger, "Inactivity strikes us as intelligent behavior." 

In short, it's one thing to feel fearful about the market. It's quite another to let that fear trump your well-laid investment plans.

Studies in Behavioral Finance clearly demonstrate that it's not your store of market knowledge that is most likely to determine your success as an investor. It's whether you let your emotions dictate your actions.
That's not a problem in good markets. The test of your resolve is times like now. 
Govern yourself accordingly.