Investing

What Stock Market Turmoil Taught Me

Hey, did anything interesting happen on Wall Street last week? I was busy and forgot to watch the news.

Just kidding. Has the market ever so closely resembled an actual roller coaster? Here’s a five-day performance chart for a fund I actually own, Vanguard Total Stock Market Index (VTSMX):

Okay, I compressed the y-axis to make it look scarier. But still, this makes the mechanical bull (and bear) look like a kitten. Normally I try to avoid following short-term market trends, but when it’s the lead story in every news source in the world, what are you going to do?

Here are a few lessons I learned during that turbulent week.

1. The market is like a big baby

When my wife and I were home with our newborn daughter in 2004, my mom gave me a piece of advice that has stuck with me: whatever thing the baby is doing today that is driving you insane, wait a week or two and she’ll have moved on to something else.

My daughter is seven now, and this is still great advice. What goes for parents goes for stock market investors: your kids and your investments will have some terrible weeks, but over the long term, everything will probably turn out okay and you may even forget what it was like to be up at 2am with a crying baby and/or Google Finance.

2. You came to dance, right?

Wait, maybe the baby analogy isn’t quite right, because the stock market never grows up. Let’s try this another way, also involving my mom.

My mom works for a business that hosts book events for authors—especially chefs—visiting Seattle. Once, they did an event for a European chef with a lifelong bad-boy Peter Pan reputation. Halfway through the evening, he got drunk and started hitting on every woman within his line of sight. My mother seemed genuinely surprised by this.

Similarly, in a recent column for SmartMoney, Jack Hough writes, “The stock market just doesn’t seem as reliable as it used to be.”

Really? The stock market used to seem reliable? Did it seem reliable in October 1987? In 2001-2002? In fall of 2008?

If you invest in stocks, sooner or later they’re going to get drunk and throw up on you. If you were alive in 2008, you already knew this, right?

3. It’s hard to stand around during the apocalypse

Now, if it sounds like I’m telling you to get out of stocks because they’re a drunk baby, that’s not what I mean. In fact, like most of the financial press, I’m telling you not to do anything, because investment decisions made hastily out of fear are rarely wise.

A few months ago, I wrote a column about developing your investment policy statement. An IPS, I said, is supposed to sound like this:

“Dear Future Me: Next time the stuff hits the fan, don’t do anything stupid. Sincerely, 2011 Me.”

Well, it’s still 2011, but I think it would be fair to describe last week as stuff hitting the fan. (Which also reminds me of having a newborn, but that’s another story.) All week, I was honestly tempted to do something. My stocks were down. My bonds were up. Should I rebalance by selling some bonds and buying some stocks?

My IPS said no, don’t do anything, because you already decided to rebalance once a year, not whenever you see a gyrating stock chart. So I didn’t do anything. Well, I drank a mojito and did some karaoke.

Speaking of bonds going up…

4. Diversification still works

My portfolio consists of 60 percent stocks and 40 percent US treasury bonds—you know, those bonds that just lost their AAA rating. One reason to hold bonds is to dampen volatility in your portfolio, to make it a less wild ride than if you held 100 percent stocks.

This strategy has worked fantastically well in the past week, especially for holders of treasury bonds, because the same investors who got scared and sold stocks last week piled into treasury bonds and drove up the price, S&P be damned. As a result, even when the stock market was swinging 5 percent per day and riding the Cyclone, my overall portfolio took the kiddie coaster.

That’s no guarantee of future performance: sometimes stocks and bonds plummet on the same day. But if you hear anyone say “diversification is dead” or “get out of bonds,” August 2011 should be enough to convince them otherwise.

Unless you’re talking to a drunk baby.

Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster.