Lessons from a market correction

Stock-market corrections shatter investors` confidence. This causes them to forget the bedrock rules for long-term investment success. Investors outperform market averages when they stick to the right strategy. I share five lessons from a market correction that will help you be a better investor in the future.

Hugh F. Doherty, DDS, CFP

Stock-market corrections shatter investors` confidence. This causes them to forget the bedrock rules for long-term investment success. Investors outperform market averages when they stick to the right strategy. I share five lessons from a market correction that will help you be a better investor in the future.

Stocks really are risky. Over the long term, stocks have returned an average six percentage points per year more than bonds. That gap is called the equity-risk premium. It is your reward for taking the extra risk associated with stocks over the bonds.

The longer the market rallies and the higher it goes, the easier it is to overlook the perils inherent in stock-market investing. The existence of the equity-risk premium is absolute proof that, over the years, stocks have been a risky investment.

Historically, it`s safe to remain 80 percent invested in stocks and 20 percent in bonds if you won`t need your money for at least 10 years. If you`ll need your money sooner - or if you just want to follow a risk-averse strategy - there are various allocations that take the equity-risk premium into account. For example, if you are a conservative investor, this might be a way to go: 40 percent large-cap value stocks or funds - 10 percent small-cap growth stocks or funds - 30 percent intermediate-term Treasury securities - 20 percent Treasury bills.

(1) Valuations for even the most promising stocks can get out of whack. Study a stock`s valuations. Beware of stocks that sell above-market valuations, no matter how compelling their stories are.

Opportunity might be now. Now you can buy stocks that should have double-digit earnings growth over the next 12 to 18 months for as little as 10 times earnings.

Examples:

Y Apple Computer, Inc.

Y Best Buy Co., Inc. - retailer of consumer electronics and appliances

Y Oshkosh B`Gosh, Inc. makes clothes for adults and children

Y The TJX Companies, Inc. owns off-price specialty stores

Y Trans World Entertainment Corp., sells recorded music and videos.

à Yield does matter. When the long bull market drove dividend yields to record lows, the conventional wisdom became that yields don`t matter. But they do. A good high-yield stock gives you the income stream you would get if you were invested in bonds, along with the opportunity for capital appreciation that comes with owning common stock.

The market is filled with large-cap value stocks, from market-dominating companies, that currently yield about 5 percent. These were wallflowers during the long bull market. They sat on the sidelines while investors gobbled up large-cap growth stocks.

(2) A stock portfolio isn`t a bank account. That should go without saying. But after three straight years of out-sized, stock-market gains, plenty of people invested their next auto payment in the market, hoping for a quick 20 percent before the payment came due. That`s not investing. That`s gambling.

If you have money that you must pay out - to make an auto payment or pay your credit-card installment or even buy a house - it belongs in safe, liquid investments (T-bills or money-market funds), not in the stock market. The stock market is only for long-term investors who won`t need the money for a bare minimum of five years ... and I would rather make that eight years.

(3) Don`t turn temporary losses into permanent losses. As long as you hold the stock, your loss is temporary. In time, the market will recover and your stock will most likely recover with it - provided the stock`s financials are in good shape. But if you sell the stock, your loss becomes permanent. Stay a long-term investor, no matter how grim things look in the short term. Be as dispassionate and unemotional as possible. When you become emotional over money, you will be a loser.

Hugh F. Doherty, DDS, CFP, is a national lecturer, financial advisor to the health-care profession, and CEO of Doctor`s Financial Network. For personal financial consultations or to have Dr. Doherty speak to your study club or dental society, contact him at (800) 544-9653. E-mail: Drfinnet@aol.com. Web site: www.dr.hughdoherty.com.

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