Five Ways to Keep Your Cool in Wild Markets

Here are some productive activities to burn off nervous energy.

Christine Benz 25 May, 2010 | 0:00
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Question: I've heard about the importance of not panicking when the market swoons like it has during the past few weeks. But I can't stand watching my portfolio lose money day by day, and I'm worried we're in for a repeat of 2008/early 2009. Any tips?  

Answer: If you're an investor who has a hard time tuning out the day-to-day market noise--and there's been a lot of it lately--you need to find a set of tasks that will burn off your nervous energy and help you channel it into something more productive.

Tackling activities like the ones that follow is a good way to win back control in what has been an unnerving market environment. So when things are going from bad to worse in Greece (or Spain, or Portugal...), you can take comfort in knowing that you're doing your fair share to influence your investment results for the better.

Here are five ways you can remain calm even when the market is not.

1. Check to see if rebalancing is in order.
One of the biggest mistakes investors can make is to be too reactive when the market is volatile (or even when it's not), venturing into and out of stocks based on headlines rather than real, fundamental reasons. Instead, a better strategy is to put your time into crafting an asset-allocation blueprint that makes sense for you, then making adjustments only when your current allocations veer from your targets in a meaningful way.

I usually define "meaningful" as a 5- or 10-percentage point drift in your asset allocation versus your targets. Given that the U.S. stock market officially broached "correction" territory last week, meaning that stocks had dropped by 10 percentage points, and foreign stocks have fallen even further, it's worth investigating whether it's time to rebalance. Morningstar's Instant X-Ray tool can be an invaluable way to get a precise read on where your asset mix currently stands.

2. Upgrade/take risk off the table.
If your asset-allocation review showed that you need to make some changes--or even if it didn't--it's also a good time to take a look at how your portfolio is positioned on an intra-asset-class basis. Following a sharp runup in risky, economically sensitive assets (for example, high-yield bonds, many small-cap stocks) during the past year-plus, your portfolio may be heavier on such names than you intended it to be. Meanwhile, our equity analysts have been arguing that so-called wide-moat stocks--high-quality companies with sustainable competitive advantages and cash-flow-rich businesses--look relatively cheap right now.

All in all, it's looking like a good time to upgrade the quality of your portfolio while taking some risk off the table. Using our  Premium Stock Screener to home in on 5-star wide-moat stocks (which, by the way, is a growing list) is one way to boost your portfolio's exposure to high-quality names. If you're a mutual fund buyer attempting to discern what's cheap and what's dear now, our ETF Valuation Quickrank can provide a good lens through which you can view the valuations of various stock categories. (This tool comes in handy even if you're not an ETF investor.)

3. Increase your savings rate. (Refinancing, anyone?)
The biggest lever any of us have as investors is how much we've saved, so one sure way to seize control in a volatile market is to simply stash more away.

That's easier said than done, of course. But if you have a mortgage, it's a good time to investigate whether you can reduce your borrowing costs by refinancing. Mortgage rates are currently scraping 50-year lows, a byproduct of the fact that U.S.-denominated debt has been viewed as a safe haven amid Europe's troubles. That has exerted downward pressure on bond yields, and, in turn, mortgage rates. The average rate for 30-year mortgages is less than 5% currently, according to bankrate.com, whereas 15-year mortgage holders should be able to lock in a rate closer to 4.25%. Cutting those financing costs will dramatically reduce your monthly outlay each month, thereby boosting the amount you have at your disposal for saving and investing.

4. Check up on what you're paying.
Also under the heading of factors you exert control over is how much you're paying in investment-related costs. True, each of your investment expenses might not look large on a one-off basis--it's hard to get excited about whether you're paying $10 or $15 for trades, or whether your fund charges you 0.75% per year or twice that much. When these costs are rolled up together and compounded over many years, however, they can have a significant impact on returns.

Regular Morningstar.com users know that we're always evangelizing about the importance of keeping mutual fund expense ratios low; I usually say it's a mistake to pay much more than 1.0% for stock funds or more than 0.75% for bond funds. Morningstar's Cost Analyzer can help you compare the expenses of two funds or ETFs.

Limiting your own trading, while invariably a good idea from an investment standpoint, has the salutary effect of reducing the commissions you pay on an ongoing basis; it may also reduce your tax costs (more on this topic below). Finally, keep close tabs on any additional layers of expenses you're paying, whether to your financial advisor or to be part of a company-retirement plan. Some of these costs are invisible, in that you don't actually write a check to the service provider, but they can take a bite out of your returns all the same. 

5. Reduce investment-related tax costs.
In a related vein, stressed investors can also take comfort in knowing they exert significant control over their investment-related tax costs. There are myriad ways to cut investment-related taxes, but one starting point is to contribute the maximum to any tax-sheltered investment vehicles you can avail yourself of, including 401(k)s and IRAs. Such vehicles can reduce the investment-related taxes you owe from year to year; Russ Kinnel identified some of the best investment types for these accounts in this article.

Whether you store assets in your taxable or tax-sheltered account is another important lever that can boost your take-home returns; that topic is the focus of this column, while this article discusses how to sequence your withdrawals from your various accounts to maximize your returns during retirement.

And to the extent that you invest in your taxable account, you can also take advantage of tax-minimization techniques. I outline some of the best ideas for doing so in this article.

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About Author

Christine Benz  Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz and on Facebook.

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