How can an investor prepare for market corrections?
Posted August 11, 2011on:
The common approach to dealing with a market correction is trying to get out of the way at the first sign of trouble before the big one hits, like getting out after a 5% dip before the 30% drop hits. This approach requires perfect foresight. God can do that, not you, and certainly not a financial advisor who needs the job to make a living. (FYI, only one out of every thirty 5% dips turns into a 30% fall.)
The prudent approach is to have a balanced diversified portfolio with the bond portion very pure. Take a 50/50 portfolio for example. During the recent market correction, the equity portion dropped 15%, but the bond portion rallied 5%. Net net, the portfolio lost 5% in value. Not good, but far from the end of the world. On top of that, if you do a rebalance at this time (like I did for my clients), you pick up shares at a 15% discount.
The prudent approach does not require perfect foresight to succeed; it requires discipline though, which is pretty hard by itself. But discipline is something you can develop; short of that, there are many good financial advisors out there who can help.
Harry Markowitz, shown in the picture above, is a Noble Laureate of Economics for his contribution to Modern Portfolio Theory. How does he invest his money? None other than a 50/50 portfolio.
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