What happens when markets suffer a panic?

Well, a lot of things: investors deal with emotional outbursts, a frenzy of talking heads, and lots of really bad advice. At the same time, these dislocations create opportunity -- if you manage to keep your wits about you.

From an interesting article in the WSJ this week, comes this modified list.

1. Invest during a panic: When panic hits the front pages, put a toe in the water.

2. Don't speculate: Look for securities that offer modest, but predictable gains. Think Warren Buffett, not Steve Cohen.

3. Don't make too many bets: Feel free to sit most hands out. You should only place your bet when you really like the odds. You can be diversified without owning every asset class.

4. Be very wary of any boom: Remember, price matters. Avoid buying into the hockey stick part of a surge -- that's way late in the cycle. If you are early into a sector, you should sell off 10% into each quarterly surge.

5. Don't put too much weight on expert financial analysis: Learn to become a self-sufficient investor. We have seen too many examples of where most Economists got the big picture way wrong, and when analysts were compromised by their firms.

6. Do you really need to pick individual stocks? Most people suck at stock picking. Given the universe of ETFs, you have a lot of options without the individual stock risk.

7. Invest in stages: 99% of people will not pick the bottom; even less get out right at the top. Use dollar cost monthly averaging with indexes, and invest over time.

8. Only invest for the long-term: That means five years or more. On rare occasions, it means 10-15 years. Daily moves are noise; focus on the signal.

9. Consider a really good active fund manager: They do exist, but they are rare. Look for mutual funds where the manager has a terrific long term record -- ideally 10 years or more.

10. Everything has risk -- even cash: Try thinking about what inflation is going to do to you if you sit in cash on the sidelines. There are, literally, no risk-free places to hold money.

A few caveats to the above:

a) Your own retirement timeline is very important. If you are 10 years or less from retirement, you need to be more conservative.

b) Know thyself. If you cannot deal with being underwater, then you must adjust accordingly. Long term is really very long term. That may mean patiently waiting for a decade or so -- think Japan in the 1990s, or the US from 1966 to 1982.

c) Inflation is pernicious, always present -- even when it's less than 2%.

d) The time you have to manage your assets will determine how active you can be. Dollar cost averaging requires the least amount of time and effort.

e) Simpler is better.

Source:
Opportunity in Credit Crisis
BRETT ARENDS
WSJ, March 19, 2008

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Barry Ritholtz

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