Plan for the worst, hope for the best

By any historical standard, 2013 was a great year for the U.S. stock markets. The Dow Jones Industrial Average and S&P 500 each rose more than 25 percent and the majority of investors enjoyed a profitable year. In addition to great gains, 2013 was marked by historically low volatility. In most years, the markets experience a decline of 10 percent or more at some point. But not in 2013 when the single biggest dip was a relatively minor 7 percent drawdown.

And as if that wasn’t enough to get investors feeling good, there’s a historical precedent for one positive year to be followed by another. Data from the independent investment research group BCA Research shows that since 1870, there have been 30 years in which the U.S. stock markets increased by at least 25 percent. Out of those 30 years, 23 were followed by another year of positive return. That’s a 77 percent success ratio.

But before you get too excited and carefree with your money, there’s another bit of research to consider.

According to the Stock Trader’s Almanac, 35 of the past 41 Januaries in which positive gains were experienced during the first five days of trading were followed by full-year gains. Unfortunately, the first five trading days of 2014 saw a small cumulative loss.

So what’s an investor to do with contradicting indicators?

My advice: plan for the worst, hope for the best.

Now, while all is well, is the time to review your risk tolerance and financial objectives and to develop a sell-discipline. That is, determine now what will be the triggers or specific points at which you will sell your investment(s). Establishing those points now, rather than when things are looking bleak, will make it easier to follow through with your decision. A well-thought out plan for the worst will actually help you get through the worst.

And because every storm eventually passes, you also need to develop a plan for how and when you’ll respond to positive market changes. Like your plan for the worst, establish what it will take to get you back in the game. Do it now while you’re not feeling gun shy from a few losses.

While nobody knows for certain if the markets will soar or suffer in 2014, disciplined buy and sell strategies that plan for the worst and hope for the best will help you brave the year with confidence. And in a world of volatile investing, that very often is the best for which you can hope.