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Investor clinic

Six tips for coping with market mayhem Add to ...

Cue the flashbacks to 2008.

With Deutsche Bank’s stock plunging and the outlook for Germany’s largest lender changing by the hour this week, some investors have worried that another financial crisis may be about to wreak havoc on global markets.

For now, at least, we can all take a deep breath. Having shed about half of their value this year, Deutsche Bank’s battered shares surged Friday on reports that the U.S. Justice Department may be poised to dramatically reduce the $14-billion (U.S.) fine it had been considering over the bank’s sales of mortgage-backed securities.

But even though a crisis appears to have been averted, let’s not squander this glowing opportunity to consider what would happen if markets actually did spin out of control. Would you be ready?

If Deutsche Bank doesn’t spark the next panic, I can assure you something else will. After all, stock market meltdowns are like natural disasters – they’re unpredictable and unavoidable. They can also wreck your financial plan if you don’t know how to respond.

With your financial – and emotional – well-being in mind, here are six tips for coping with market mayhem when it does happen.

As the Boy Scouts say: ‘Be prepared’

A global market rout is not the time to assess whether your portfolio is properly diversified and suited to your risk tolerance. The time to do that is before all heck breaks loose. Do you own speculative shares in money-losing companies? Is too much of your portfolio in a single sector? (Canadian banks, anyone?) Is your weighting toward equities so aggressive that you might abandon ship when markets sink? Ask yourself the hard questions now and make any changes you deem necessary; you may save yourself a lot of disappointment later.

Write this down

Investors who work with an adviser often create an investment-policy statement that summarizes their investing strategy, target asset allocation, investing horizon and goals. Putting the information in writing helps both the client and the adviser stick with a disciplined investing plan through good times and bad. But even do-it-yourself investors can benefit from having a policy statement. It can be a long, detailed document or just a few sentences that you can read whenever you feel the temptation to stray from your strategy. For example: “I recognize that market volatility – sometimes extreme market volatility – is a normal part of investing. Even though I may feel like throwing up at times, buying and holding great companies is the surest way to build wealth over the long run.”

Be an owner, not a speculator

Some investors forget – or don’t understand – the real purpose of buying a stock: To own a piece of a business and to share in its profits. Instead, they see stocks as pieces of paper – or pixels on a computer screen – to be endlessly traded. Once you understand that the value of a stock is a reflection of the earnings the company generates – and that good companies grow their earnings over time – you’ll be less likely to panic when markets get volatile. If you own an apartment building that pays you a steady rental income, would you sell it just because the building’s market value fell? No. Yet that’s what many investors do when the stock market tanks.

‘A man’s got to know his limitations’

I’m not sure if Dirty Harry knew anything about investing, but he’s right: Knowing your limitations is critical. If you decide to sell a bunch of stocks because the market is plunging – or because you think it’s about to plunge – will you know when to get back in? I doubt it. Like most people, you’ll probably wait until long after the market has hit bottom and prices have already risen sharply. Market rebounds often happen when we least expect them, which makes picking the bottom exceptionally tricky. During the financial crisis, the S&P 500 bottomed in March, 2009, but by September, it had soared 50 per cent. Many investors who sold were too afraid to get back in and missed out on the rebound.

Carry some cash

The best investors actually welcome market routs. That’s because, when others are selling in a panic, they get to scoop up great companies at discounted prices. Not everyone has the stomach to buy when markets are tumbling, but if a company has a strong balance sheet and a solid market position and its revenue, earning and dividends are rising – and are expected to continue rising – then a market sell-off can be a great time to put cash to work.

Count your dividends

I say this so often that people must get sick of hearing it, but it’s true: Focusing on the dividend income your portfolio generates – as opposed to the minute-by-minute fluctuations of stock prices – is a great way to cope with market volatility. Tip: Create a simple spreadsheet that tabulates your total dividend income. If you own a diversified portfolio of blue-chip dividend stocks that raise their dividends regularly, your income should go in only one direction: up. And that’s more fun than watching the market go down.

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Follow on Twitter: @johnheinzl

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