Keeping Your Cool in a Shaky Market

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1. Don't panic. Panicky behavior, especially panicky buying and selling, accomplishes absolutely nothing. Smart investors never buy in a rush or sell in a rush. It's always worthwhile to think, to consider, and to do research. Only madmen and stock traders and speculators panic. Don't do it. 2. Keep plenty of cash on hand at all times. It's very hard to think rationally about stocks if every dime you have is in stocks and if the market is falling fast. The risks of annihilation are so great at that point that panicked selling seems like a smart option. If you keep a good chunk of your assets in cash, bonds, and money market funds, however, so that you know you'll be safe, sane, and secure for a long time to come no matter how the market is gyrating, you can make a patient, sensible evaluation of the situation. Cash In, Cash Out How much cash is enough? It depends on how fast you spend it. But to keep a year's worth of living expenses in cash or near-cash (bonds, money market funds, and so on) is not foolish. At a minimum, you should have six months' worth of cash or near-cash in hand. Cash is a terrible long-term investment, and treasury bonds aren't much better. But in terms of keeping calm so that you can make sensible decisions, there's no substitute for cash. Personally, I get crazy when my cash reserves run low, which they can when employers are slow in paying me or I have sudden large expenses. For instance, I just had to have one of my embarrassingly many houses virtually demolished, re-piped, and re-floored because of a burst pipe -- not once, not twice, but three times in a short span. You would be amazed at how much cash this can burn. And waiting for the insurance to pay is a recipe for heartache. As I write this, I realize I probably should've had even more cash reserves. I easily have 18 months' worth of cash, and it's the cash I think of when I'm worried, not my endless printouts of stock. A Contagion of Panic Here's another lesson: 3. Stocks don't always fall for a good reason. Yes, there was cause for the Shanghai market to fall last week. It was up over 100 percent in approximately a year, and speculation was wild. But there was absolutely no reason at all for the cream of American stocks on the Dow and the S&P 500 to fall. It was just a contagion of panic. If you read the newspapers, keep yourself well informed, and have your eyes open, you need to ask yourself if the economy looks as if it's in real trouble. If it doesn't look that way, don't sell unless you desperately need the money. In fact, don't even sell then. Suppose there's a recession. I don't expect it, but it could happen. But suppose there is: Recessions in the past 20 years tend to be extremely short-lived. The lower stock prices that accompany a recession, and the lead-up to a recession, tend to be superb times to buy. If you can be patient, hang in there and buy when the market is low, over long periods of time, and you will be well ahead. It's always better to buy when the market is low and the outlook is dour. If you have the smarts and the courage to do it, you'll be glad you did. People rarely make a lot of money buying at peaks; they always do well buying in valleys. No Crystal Ball 4. Put not your trust in princes. Alan Greenspan is a wonderful guy. He's been a friend of my little family forever, and he spoke glowingly at my father's memorial service. But he's not the Lord God. He can't see the future, and he has no data that other economists don't have. Greenspan has a poor record indeed as a forecaster. He didn't see the collapse of 2000-2002 coming, and a few years ago he was warning that the great danger was deflation. He's a great man and was a magnificent Fed chair. But he doesn't have magical powers of foresight. In fact, neither does anyone else, including me. The conclusion: Just keep buying at a measured pace, and if the market sinks a lot, buy more. I guarantee you that's how the big boys do it. The little guys sell out at the first sign of trouble -- the ones with the private jets hang on. Two Last Lessons And, finally: 5. DIVERSIFY. I capitalize this on purpose. An investor's two best friends are time and diversification. Get the broadest possible market indexes. Spread yourself out over large and small caps. Have a large dollop of the developed foreign and a goodly chunk of the developing market. Yes, it'll be a rocky ride in China and Brazil, but over long periods you'll do great. 6. The long-term direction of the market is up. It will fluctuate, as J.P. Morgan said, but the long-term trend is up. If you can patiently stay invested and take advantage of this long-term trend, you'll come out ahead. It may take some time, but short of nuclear war -- and in that case, there won't be a thing to worry about -- you'll make money if you stay in on a broadly diversified basis. You'll be wiped out if you sell on a panic basis. So: Have plenty of cash. Be patient. Never panic. Buy when others are selling. Diversify. And, one last time, be patient.