Uncertain times demand certain understanding

Since my last column in the middle of July, the U.S. stock markets have been front-page news for all the wrong reasons.

Initially, folks were quick to blame the massive sell-off on Congress and its inability to come to agreement regarding the debt ceiling. But then poor economic news, including fear of a possible double dip recession, emerged and hastened the decline of the market, and blame quickly found a new home.

Extreme market uncertainty, such as we’re experiencing today, makes it easy to get swept up in the exercise of placing blame and, perhaps even more futilely, predicting what’s going to happen next. Just turn on any one of the major networks and you’ll no doubt find a financial talking head expending huge amounts of oxygen on the effort and getting nowhere closer to a definitive answer as to the causes or what the future holds.

And given we all know that fear of the unknown is usually worse than the actuality, I’d like to suggest that we take a slightly calmer and disciplined approach to managing money during this tenuous time by addressing two questions to which we know and/or can control the answers.

Here’s the first: If this is just the start of a major decline, what is your plan to protect your portfolio and have you determined what metrics will trigger a defensive action?

In order to protect your investments, it’s important to be clear on how and when you’ll take action. Take a look at each of your holdings and draw a line in the sand where, if the price goes below a certain point, you sell. Could you end up selling at or near the bottom? Absolutely. But if your stop-loss point is 10 percent below your investment’s current value and that investment continues to go down another 30 percent, you will be glad you sold. If you do sell and the market quickly starts to recover, the worst that could happen is you might leave some money on the table before getting back in. But, in all likelihood, that small amount simply won’t compare to the possible loss you’re working to avoid.

The second question is this: If the market has reached or almost reached bottom, do you have a wish-list of investments you are ready to act on once the recovery begins?

The truth is markets don’t go down forever. Waiting for the all-clear sign to begin thinking about getting back in is a sure-fire way to miss some key opportunities. Instead, begin making a list now of investments that are holding up the strongest during the decline. Because the markets act on supply and demand, it is likely that investments that aren’t falling as far as others will continue to perform well when the markets improve.

Having a vision and a plan of action in place will enable you to make more consistent and profitable investment decisions during the up periods in the markets and may help minimize the downside during the bad. But, perhaps more importantly, it will provide you with some peace of mind during a turbulent time. And as we all know, the value of that in any market situation is priceless.