How To Know When To Get Out Of The Market

Originally published CNBCHas the market’s recent volatility worried you? Me too. It’s inevitable. Apparently, it’s how we’re wired. But better understanding that wiring can give us a clear decision-making framework to help us know if and when to get out of the market.

The field of behavioral finance has demonstrated that the pain we derive from market losses impacts us twice as much as the pleasure we feel from market gains. For this reason, investors are well served to name and address these emotions instead of setting them aside as they (unfortunately) have been taught.

We’ve all heard of the cost/benefit decision-making model, but “cost” and “benefit” are intellectual constructs too distant from the actual emotions that drive our decision-making. We need to address the gut—the “pain” and the “pleasure” associated with a tough decision. The following four-step model seeks to merge the head and the gut. And while it’s applicable in virtually any either/or scenario, let’s specifically address the decision to stay invested in the market or to move to cash:

Market Decision Image Cropped

1) The pain of staying invested is that I could lose even more.

Does Greece Really Matter?

The Bigger Picture for You and Your Portfolio

Originally in Forbes“Greece is a tiny player in global capital markets. Its default is 100% certain,” says Larry Swedroe, Director of Research for The BAM ALLIANCE and the author of 14 books on investing, including his most recent, The Incredible Shrinking Alpha, co-authored with Andrew Berkin.

“The only question is how much and what they default on,” Swedroe continues. “But with a GNP that is similar to Rhode Island’s, Greece’s default should have little to no impact on the world’s economy, at least not directly.”

So why is everyone so worried?

Because raging forest fires are kindled from a single, tiny spark. “Greece’s default could trigger a broader contagion, like a run on Portuguese banks or a lack of confidence in the ECU, that may have wider ranging implications for larger economies,” says Swedroe, my colleague.

5 Ways To Prepare Your Portfolio For A Government Shutdown

Screen Shot 2013-09-25 at 7.11.50 PM

Tim discussed this issue on CNBC this week.

We all stare agape, shocked that the U.S. government has allowed splintered self-interest to rise above its collective duty.  No, we’re actually not surprised.  Sadly, we’ve come to expect this.  The question we have to answer is: Are we going to alter our lives, our financial plans and our portfolio strategies to accommodate D.C. drama?

Unfortunately, there isn’t a specific portfolio prescription for political gamesmanship or government gridlock.  Heavy handed federal influence in the aughts, especially since 2008, has taught all of us that the government may impose its fractured will at any time, effectively changing the rules of the game.  But the strategy to deal with this is little different from dealing with one of the market’s constants: UNCERTAINTY.  Consider utilizing the following five strategies in response to today’s brand of uncertainty:

1. IF you have created a portfolio that is designed to accomplish your objectives over the long-term through deliberate diversification, you may be wise to respond to the news of a government shutdown by simply IGNORING it.  (This is my favorite response.)

2. Crises of every variety can serve as a good reminder to do what we should be doing anyway in our management of investments—like reallocating. This may be a particularly good time to siphon some U.S. exposure, which has been on a seemingly undeserved tear this year, shifting it to the international exposure in your portfolio which has likely lagged.

3. Regardless of the market’s direction, increased uncertainty tends to create more volatility in the markets.  If your sanity will only be maintained by “doing something” at this time, you may respond to this aggressively by purchasing the VIX through a volatility index that rises when the spread between market peaks and valleys rises.  Or, respond conservatively by increasing cash allocations.

4. If this government standoff extends, the economy’s recent trend toward optimism may also revert, causing the Fed to balk at its expressed intent to taper its bond-buying.  If so, you might get another chance to re-finance your mortgage and slow any strategies you’ve employed that are designed to hedge against rising interest rates.

5. Recession (or depression) in Europe, protracted Middle-East conflicts, war in Syria, slowed growth in China, student debt bubble, government debt bubble… Take your pick of the crisis du jour that could send our high-flying S&P 500 into the correction (or worse) many feel it deserves.  Could a government shut-down be the back-breaking straw for this weary camel?  If you rode the market all the way down and then all the way up, it might be a good time to conduct a portfolio analysis with the goal of making capital preservation a higher priority.  To stay on the ride isn’t investing—it’s gambling.

Inaction is likely the best action to take in the face of this month’s government drama as long as you have a well-conceived, well-implemented investment strategy.  But this flavor of uncertainty could also be a great reminder to do what you should be doing anyway—ensuring that your portfolio is not a collection of hunches but a well-oiled machine constructed of wisdom, knowledge and foresight.

If you enjoyed this post, please let me know on Twitter at @TimMaurer, and if you’d like to receive my weekly post via email, click HERE.