The Stock Market is a Roller Coaster: Prepare for the Ups and Downs

IT'S REMINISCENT OF THE OLD children's tale about an old Chinese farmer who tells his friends his story, and they enjoin with "That's good" or "That's bad" on alternating lines:

Farmer: My horse ran away.

Friends: That's bad.

Farmer: She came back with a majestic stallion by her side.

Friends: That's good.

Farmer: My son tried to ride the stallion and broke his hip.

Friends: That's bad.

Farmer: The emperor came through town that week and took every able-bodied young man away to war. My son was spared.

Friends: That's good, et cetera.

Recent market trends bring this story to mind. On this emotional roller coaster, it's hard to know whether to laugh or cry. For all practical purposes, the war is over. That's good. But the battle to win over Iraq has just begun. That's bad. The markets in the U.S. have been cheered by the quick success. Good. The Japanese market has hit a new 20-year low. Bad. We could go on. It's been a wild month for news.

Fears of the SARS epidemic have hit economies in East Asia and Canada and further injured an already-weakened airline industry. A bigger question is how devastating the epidemic will become, and will it hinder an already weak recovery, or worse yet become a worldwide epidemic. Embezzlement charges caused a temporary bank run among recent immigrants who weren't aware of FDIC insurance at Abacus Federal Savings Bank in New York's Chinatown. Earnings news is rather positive, despite a few negatives. Many big names have provided surprises on the upside, while fewer companies are disappointing analysts, it seems.

Despite the recent uptrend in U.S. markets, most investors aren't particularly cheered. Most still wonder how long it will take to recover what was lost in the past few years. That focus, however, won't make the recovery come any sooner. We need to be happy with 10% growth, a substantial positive trend for those who aren't carrying any baggage. Too, for those who put their money in, instead of following the crowd and taking it out, 10% growth ought to compensate for twice the losses. The real question is whether individual investors will continue to run for the exits, hold their ground, or redouble their efforts to save and invest more.

I'm continually amazed how investors put more money in when markets are topping out, and pull money back when markets are at or near bottoms. Described in that way, virtually no one would do it, but when we add the emotional component, it is really quite easy to understand. Market bottoms come after drops, which often come with reduced portfolio values and emotional turmoil. In addition, drops come when the economy is weak, and many people need to use their money for personal or family needs while income is temporarily reduced. This underlies the primary weakness of the buy-and-hold strategy. This solid strategy is only successful if held to consistently. However, most people cannot or will not follow through on it in difficult times. Thus, it may be less effective than we traditionally imagine. No, the strategy itself is not flawed, but practically speaking, it may not be viable for real life.

Each investor needs to consider his/her own investing patterns. If you are inclined to disinvest during downtimes, a thorough re-evaluation may be in line. Re-evaluate both your strategy choices and your ability to maintain them. If you are unable to keep focused or are likely to have circumstance which prevent you from following your strategy when its most important, you need a different approach. There's no benefit to having a wonderful game-plan that you can't follow. Imagine a basketball coach whose plan includes putting in Michael Jordan when the team gets behind, but Michael Jordan isn't on the team! If you are unable to follow a buy-and-hold strategy, your ability to profit in downtimes is severely restrained. Sadly, this is when the greatest opportunity is available. Thus, a compensating strategy must be developed.

Investors must realize, however, that increasing returns often comes with higher risk. Thus, if one cannot buy and hold when one finds it unpleasant, the other alternatives involve taking on greater risk. No one really wants to hear that, but it is hard truth. High returns require higher risk, and if you are unable to "weather the storm" in times like this (what I call easy risk), you'll need to take larger short-term risks (hard risk), or else consign oneself to lower returns.

Easy risk is a long-term safety play. We risk that valuations will fluctuate, but over the long term we have confidence that they will be relatively stable. We give up our ability to observe high valuations, knowing that what we own is still the same.

Hard risk involves taking real, serious, short-term gambles. It is not a strategy that I advise, nor is it the wisest approach to investing, but it is a corner that people sometimes paint themselves into. That's bad!

We continue to advise our readers to stick with the buy-and-hold strategy. While there is obviously risk of fluctuating prices, these tend to balance themselves out in the long-run. If you have a long-run focus, buy-and hold is still the safest approach. That's good!

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Scott Pearson is an investment advisor, writer, editor, instructor, and business leader. As President and Chief Investment Officer of Value View Financial Corp., he offers investment management services to a wide variety of clients. His own newsletter, Investor's Value View, is distributed worldwide and provides general money tips and investment advice to readers both internationally, and in the U.S.