The Dow Jones Index (DJI) closed above 15,000 for the first time in history last week. This puts the major stock indexes – Dow Jones, S&P 500, and the Nasdaq – up 15.37%, 14.55%, and 13.81% for the year.
Is this a time for investors to be fearful or greedy? Should you follow the old adage “sell in May and go away” this year? With the markets up so much in such a short period of time some investors and wondering if they should back out of their stock investments now.
How to React to Market News
There are three ways you can react to any market news not just the Dow Jones Industrial Average hitting a new high.
Follow the Momentum
One reaction is to try and ride the waves of momentum that occur in the stock exchanges. If everyone is buying that drives the price up, so buy now and sell at some point in the future when the price has risen to an acceptable profit level. This works in reverse, too. You can short stocks (or ETFs if you prefer) as the market goes down and generate profit there as well.
The problem with this reaction is that it is based on speculation and emotion. It may pay off, but when things turn against the momentum when you don’t expect it you can be left holding the bag.
React out of Fear
Another common reaction is to simply react out of fear. You can see this in some of the financial headlines today:
- The Dow closes above 15,000 but the economy is still in shambles.
- Unemployment is still rampant.
- You need to worry about the debt ceiling and what Congress is going to do.
These are designed to get an emotional reaction out of you. To get you to do something, anything. That means more trades and commissions for brokers, and an increased likelihood you will sell shares when you shouldn’t.
Fear is a powerful motivator. It can cause us to sell all of our stock based investments at the worst time and never get back in.
Take the case of investors that fled the stock markets after the financial crisis of 2008. The S&P 500 hit a low of 683.38 on March 6, 2009. Since then it has gained 122%.
If you had abandoned stocks then you missed out on a great 4 year rally that helped wipe out some of the losses that you took during the crisis.
The fear the comes into play with the Dow hitting 15,000 is that the stock market has risen too much and is due for a pull back. While that may be true, there is no telling how long the current rally will last. It makes timing the market difficult – as it always is.
Follow an Investment Plan
The best way to react to any market news is to follow your investment plan. Instead of following the herd or reacting based on emotions, you calmly follow what your investment plan says you should do. Or shouldn’t do — it just depends on your plan.
How an Investment Plan Protects Your Portfolio
When fear or irrational decisions like following the herd (up or down) are causing you to make foolish investment decisions, an investment plan steps in to correct your actions.
What is an Investment Plan?
An investment plan is a simple plan – on paper, electronic form, or some combination of the two – that clearly outlines your long term investing philosophy and strategy. You detail out things such as how you react to the ups and downs of the market, how often you invest, and how to allocate your invested assets.
Much like budgeting, some people think putting together a plan will be too difficult to do without professional help. It doesn’t have to be this complex presentation that an advisor puts together for you. You can write out a plan in a document that is one page long.
The key is to make sure you actually refer to your investment plan when facing difficult investing decision. It does you no good to put together then plan and then do nothing with it.
Here are two ways an investment plan helps you:
Eliminates Rushed Decisions
When the Dow Jones Industrial Average is surging above 15,000 or crashing below 7,000 you are more apt to feel the pressure of making a decision to do something, anything. Sometimes the best decision is to do nothing at all and just to ride the ups and downs of the market.
Your investment plan should tell how you to react when the market is going crazy. Should you rebalance your asset allocation? Should you sit tight?
Don’t let your emotions get involved because they will tend to tell you to go with the herd. Sticking to your plan eliminates that.
Eliminates Judgment Calls
A quality investment plan will assist you by avoiding judgment calls. Is 14,500 too high for the DJIA? Or is it 14,760? Or 14,904?
Your plan should tell you when and how often to rebalance your portfolio to your target allocation. Instead of sitting around wondering when the right time to buy or sell into the market is, your plan tells you every time.
Does Require Thought
It can seem like relying so heavily on your investing plan removes the thinking out of investing.
In one way this is true and quite the good thing: you are eliminating your emotions from ruining your investments.
But that isn’t to say you aren’t thinking at all. In fact putting together an investment plan is simply front loading all of the thinking and tough decision making for the next several years. Instead of doing your thinking in an emotional state and on a fast timeline, you think about different situations in the beginning before those tough times come. That makes making the decision a lot easier than doing it in the moment.
How Should You React to Dow 15,000?
Simply put: what does your investment plan tell you to do? Some investors will rebalance their portfolios. Others will pour more money into their investments. And others will pull out of stocks and hold cash.
What will you do?
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