If you watch the financial markets, you have seen just about everything in the last several weeks.
First, the Dow Jones Industrial Average raced from 13,000 to 14,000 in record time. Then, in a matter of two days, the Dow gave up about half this gain. What is a long-term investor to do?
Before we answer that question, it might be useful for you to understand why the market soared so quickly and then plunged so far and so fast.
The Dow's big gain was fueled in a large part by strong corporate profits, low interest rates and relatively low inflation. In the past few weeks, those impressive corporate profits and the economic boom in Asia helped kick already-high oil prices even higher.
Furthermore, we've seen some trouble spots in the U.S. economy, accompanied by difficulties in borrowing for companies that already have high debt loads or poor credit.
These factors are widely thought to be somewhat responsible for the sell-off in stocks. (The Dow Jones Industrial Average is an unmanaged index and not available for direct investment.)
Will the decline continue, and, if it does, how far will stock prices fall?
No one can really answer these questions with any certainty. Market declines often begin and end without warning. However, regardless of the length and severity of a market downturn, you will want to consider these moves:
Focus on quality
There's never a "wrong" time to buy quality investments -- but there's also never a better time than when the market is shaky.
Quite simply, during market downturns, quality investments -- such as stocks of some large companies in developed markets and top-rated corporate bonds -- historically tend to not drop as far as riskier investments. Past performance is not an indication of future results.
Look for buying opportunities. Everybody knows that it's a good idea to "buy low and sell high," but many investors do just the opposite: They chase after "hot" stocks, whose price may already be peaking, and they sell stocks whose price is falling, in an effort to "cut losses."
The best buying opportunities often occur when the market is down. That is because a market slump tends to drag down all stocks, even those with good prospects for future growth. Consequently, you might find "good deals" among those stocks whose fundamentals are strong but whose price has dropped substantially.
Think long term
The market decline was big news. But, as weeks turn into months, and months into years, will the impact of this drop be meaningful? We just don't know.
To put some perspective on this question, look back 20 years, to the summer of 1987. In 1987 the Dow Jones Industrial Average stood at around 2,500. Since that time, the Dow has gone up more than 400 percent.
Of course, as you have no doubt heard, past performance is no guarantee of future results. So, if you don't let short-term drops send you to the investment "sidelines," your patience and perseverance may give you an opportunity to be well positioned for the long term.
No one likes to see the stock market shed so much wealth, in a short period of time.
If you concentrate on quality, look for good deals and think long term, you can navigate the sometimes-bumpy roads of the investment world and continue on your journey toward your important financial goals.
-- G. Scott Flake is a licensed financial adviser with Edward Jones. For more information, call him at (928) 468-1470.