The Investment Scientist

How can an investor prepare for market corrections?

Posted on: August 11, 2011

Harry Markowitz

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.

Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.

1 Response to "How can an investor prepare for market corrections?"

Michael,

Where’d you get the data that only one out of every 30 5% dips turns into a 30% fall?

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



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