News flash: sometimes shares go down. You have to prepare for market declines — or else you'll be a sitting duck when they inevitably come.
As silly as that statement is, it's easy to understand how investors can forget about the risks of the share market from time to time.
After all, when the market moves steadily upward for months on end, without even suffering minor hiccups along the way, it can lull you into a false sense of security that shares will always be as well-behaved as they've been lately.
Until this week, at least.
Defying gravity
US markets fell 2% on Tuesday. They fell another 1% on Wednesday. Naturally, like a little lost sheep, the Aussie markets followed suit.
Such drops aren't particularly remarkable in themselves. With problems in northern Africa spreading to Libya over the weekend, fears of the high oil price slowing already struggling economies, the tragic NZ earthquake, and protracted tension among the oil-producing regions of the world, it all combined to send markets south.
Energy-related companies like BHP Billiton (ASX: BHP) and Woodside Petroleum (ASX: WPL) missed the worst of the losses, helped by the significant rises in crude oil prices.
But most of the rest of the market was down sharply, for a variety of reasons, including fear, a small sense of panic, and simply a general geopolitical malaise.
Gaining perspective
What is remarkable about the big declines is we've gone so long without one of this size. Over in the US, the index went more than six months without having a day where it dropped 2%.
Those straight-up moves are nice for your portfolio when you already own shares, but they can cause you to underestimate the risk in your investment portfolio.
That's why it's important for you to take a few steps back from this week's market wobbles and take a close look at your investments.
There's no need for panic: A 2% drop is an ordinary event for shares. But taking a calculated look at your risk level always makes sense, especially when bad news or other concerns make the future look less rosy.
In particular, here are a few things to take a look at:
- Have you rebalanced your portfolio recently? If not, the fact that the ASX/S&P 200 is up 45% from its March 2009 lows means that you may have more of your money in shares than you realise. If your overall asset allocation isn't in line with your risk tolerance, then making changes to shift some of your share money into other investments might be a prudent move.
- Are you diversified? Making big bets on particular sectors can be lucrative when the markets are moving your way, but when they reverse, those gains can evaporate in a hurry. Moving some of your money into less volatile areas of the market can help you protect those hard-earned gains. There is more to investing than mining and resources shares.
- Have you made a shopping list? For months, investors who've been stuck on the sidelines have bemoaned the fact that the market would never give them a big dip to let them take advantage of bargain prices. Maybe your chance is coming closer. By having your watchlist set up in advance, you'll put yourself in the best position to pounce on those deals as soon as they come.
Don't panic
Sudden market declines are scary, especially when they result from dangerous situations in the world.
Long-term investors, though, remain confident that just as financial markets have gotten through past crises, they'll get through this one as well — and those who stick with their investing plans stand the best chance to profit from them…
Join The Investor Revolution
In our free email, Take Stock, we explore investing strategies, pontificate on the state of the global economy and what it might mean for your share portfolio, plus much more.
Take Stock is an integral part of The Motley Fool's Investor Revolution. If you'd like to join us on our campaign to empower individual investors, click here to enter your email address.
As you would expect from The Motley Fool, we totally respect your privacy, and we'll never sell your email onto 3rd parties.
