The Market Drops – Is It Time For Panic?

August 9th was a tough day for common stocks as the three major indexes – the S&P 500, the DJIA, and NASDAQ all fell between 5% and 7%, making August 9th the worst day on Wall Street since 2008.  In fact, over the two-week period ending on the 9th of August, U.S. stocks dropped by about 15% – to say the least, that was a cause for panic by many investors.  What do most financial advisors say?  Most (but not all) suggest that you take a deep breath and avoid panic.  Burton Malkiel, the author of A Random Walk Down Wall Street and professor emeritus at Princeton University wrote an opinion piece “Don’t Panic About the Stock Market” for The Wall Street Journal advising investors to stay the course and look to the long run.

This opinion is shared by Larry Swedroe, the director of research for the Buckingham Family of Financial Services, in his article “Don’t Panic: Stock Market Crises Are Normal” which he wrote for his Wise Investing column for MarketWatch.com.  Again, his message is to stay the course and keep your long-term plan in mind.  This has been one of his major talking points for some time.  In fact, in June 2011, his Wise Investing column was titled “Stay Focused on Your Plan During the Good Times as Well“.  In this article he stresses the need to stay rebalanced – that is, to make sure you stick with your long-term asset allocation goals.  After all, in Ch. 11 we discuss setting your investment goals, which go hand-in-hand with your long-term goals, and that’s how you should be thinking.  In Ch. 11 we also talk about asset allocation and the importance of diversification – to say the least, being diversified through the recent market turmoil has helped investors tremendously.

One last word about your asset allocation decision – as you learn in Ch. 11, when you invest you are really making two decisions.  The first one is your asset allocation – what percent of your investment goes into stocks, bonds, and cash?  The second decision involves which individual securities to buy.  Which of these decisions is the more important one?  The answer is the asset allocation decision.  Just look at what happened the week of August 8th, 2011 – stocks tanked while bonds hung in there.  So if you were only invested in stocks, it was a tough week for you – even if you picked the best stocks of the week.  But if you diversified your investments to include bonds, you’re probably feeling a bit better right now.

Discussion questions:

  1. What were some of the reasons Burton Malkiel gave for his optimism that in the long run stocks will do well?
  2. Do you agree with his reasoning?
  3. Where do you think the stock market will be heading in the next month? The next year? Why?
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