Stick to common-sense fundamentals when investing

November 1, 2007

There will always be a cycle of economic growth with periods of expansions, downturns and recessions in the market, so investors need to know the common-sense fundamentals to survive the roller coaster.

Key Points

Most recently, investors had to deal with a single week in late July that saw a 500-point drop in the Dow Jones Index (DJI). That came immediately after the Dow had set a new market high. After a brief rebound, the DJI plunged again, losing 585 points in just two days during early August.

So what does all this mean? Are these simply predictable and healthy corrections in a long-term bull market, as many financial professionals assert? Or are we headed for an investor meltdown, as predicted by some of the gloomier forecasters?

I've been around long enough to see these circumstances before, and my experience places me in the company of those experts who predict the long-term future will most likely mirror the long-term past. That is, a steady pattern of economic growth with periods of expansions, recessions and downturns in the market.

In truth, economic recessions are relatively common in our society and are a normal part of a free economy. A recession, technically speaking, is a decline in Gross Domestic Product (GDP) for at least two consecutive quarters. That definition alone makes it rather easy for us to slip into a "recession." Even with that somewhat liberal definition, recessions have become of shorter duration and much less severity than they were in the past. Many economists attribute this to the strength and flexibility of our modern economy.

According to studies by Ned Davis Research, since World War II, the average expansion in our economy has lasted 57 months, while the average recession has lasted 10 months. In the past 20 years, according to the study, we haven't had a recession lasting longer than eight months.

What all of this suggests to me is that the rules of the game of profitable investing remain pretty much the same. At the time of this writing, investor concerns focus on such things as the effects of the sub-prime mortgage crisis on the housing market, the price of oil and the threat of terrorism. While any of these may seem of formidable proportion, they are probably no worse than the concerns that bothered investors in the 1960s or the 1980s or any other period.

In short, investing for a financially healthy retirement still calls for the same kind of common-sense approach that has worked so well in the past.

Don't try to time the market

Market timing is the strategy that makes use of various fundamental and technical analysis tools in an attempt to predict future price movements of equities. Many professionals believe that you can't successfully predict market movements over time. It's more of gamble, they say, than a legitimate investing strategy.

Waiting for stocks to hit the "bottom" before you buy or hit the "top" before you sell has long since proven to be a sucker's game. Select the stocks or mutual funds that you buy on the basis of sound fundamentals.

Maintain appropriate asset allocation

If there is one point that virtually all financial advisors agree on, it's the critical need for you to maintain an asset allocation suitable to your personal circumstances. Asset allocation refers to the process of dividing your investable assets among stocks, bonds and cash.