Ken Himmler.com

In the last few days we have seen the market drop almost 2000 points off the Dow. Now people from all walks of life are wondering should I just move my money to cash to protect it until the market bottoms out?

I have heard this thinking now for twenty five years and the only thing that changes is the years that it happens. It might make sense to sell out now to be able to hold onto your principal but did those people who sold out in 1987, 1991, 1999, 2001 not learn anything?

Once you sell you lock in your losses and then you are faced with what I call the 50/100 rule. This says that if you lost 50% of your valuation you have to earn 100% to get back to even. Then what should you do during this volatility?

If you are in the accumulation stage (saving for retirement) then you should stay steady as you have a time horizon that will allow the markets to have the opportunity to return. If you are in the distribution phase (retirement) then you should have had an asset allocation strategy that has a good portion of your money in stock and in bonds. Those bonds (Government) have or should have grown in the last few weeks. This means that while you are in your distribution phase then you should be looking to take your cash flow from the bonds and leave the stock alone. If your plan was properly devised you should have at least five years worth of cash flow that can be taken from bonds.

To really help you understand how damaging it is to sell out now you should read the study H. Nejat Seyhun produced from the University of Michigan. He shows how damaging it is to try to time the market by getting out on the way down and then trying to time the best time to get back in. From 1963 to 2004 if you would have stayed in the market you would have received an average rate of return of 10.84% (based on his selection of the domestic stock market). If you would have only missed the 90 biggest gaining days during this entire period, you would have only received 3.2%.

In another study from the Journal of Investing, by only missing the 10 best trading days your return is cut in half. In simple terms – if you try to market time you will potentially lose 50% of your returns.

What do we do right now? If you have an asset allocation plan then it is time to re balance as the allocation is certainly more than 15% out of tolerance. If you don’t have an asset allocation plan then now is the time to put one in place.