Here's a Game Plan for the NEXT Time the Market Plunges

Sooner, rather than later, [excessive] volatility will break out again so it is important for investors to have a game plan in place for such a future event. [Below is just such a plan that I would like to share with you.] Words: 1469

So says Peter Hodson (www.sprott.com), in an article* originally written for the Financial Post which Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), has further edited ([  ]), abridged (…) and reformatted below  for the sake of clarity and brevity to ensure a fast and easy read. The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement. 

Hodson goes on, in part, to say:

1. Stay Calm

When confronted with a major market plunge, stay calm. Of course you have heard this before, but when fear takes over, calmness takes flight. You can literally hear calm disappear from financial commentators, as they scream at you trying to tell you to either (a) sell everything, or (b) buy everything.

If you are invested when the market [plunges]…and you don’t need that capital today, take a day, a week or a month to think about your investment strategy again. You can then execute that strategy in a rational market when markets more truly reflect what is happening in the economy. 

2. Put Decline into Historical Context

Put what is happening in the markets in their historical context. The 635-point drubbing of the Dow Jones Industrial Average on Aug. 8, for example, was only the 35^th worst drop on record. Bad, yes, but it doesn’t even make a top 20 list. We’ve all seen worse.

3. Remember Balance Sheet Strength

Sure, most governments worldwide still have debt issues, but corporations themselves have much more balance-sheet strength than they did in the 2008 crisis. Apple Inc. For example, actually has more cash than the U.S. Treasury right now. Corporate ability to withstand a recession is much better this time.

4. Consider Buying Dividend Paying Companies

Dividends represent most of an investor’s return over the long term, but another benefit of dividends is hidden but equally important – dividends can prevent you from selling, period. When you know you have nice dividend cheque coming in every three months, you can at least get paid to ride out the volatility. [See here (1) for an article suggesting such companies.]

One strategy in rough times is to buy companies that recently raised their dividends, on the assumption these companies must be performing better in the existing environment. Two examples would be Russel Metals Inc. (RUS/TSX) and Algonquin Power and Utilities Corp. (AQN/TSX). Both yield about 5% after their recent dividend increases. Plus, both pay you almost twice what you might get from government bonds these days.

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Avoid companies with any debt. Nobody knows exactly what is going to happen, but if you own debt-free companies at least you know your investments will have the financial strength to hang in there longer than a debt-laden company. In 2007 and 2008, debt killed many companies. This time around, however, it is easy to find debt-free companies, as so many hunkered down and raised cash after the last cycle. Again, like dividends, owning debt-free companies will also help you avoid panicking yourself, when everyone else seems to be.

5. Consider Buying Small-cap Companies

[While] this might seem counter-intuitive,…in times of market panic, small caps’ illiquidity clearly works against them. During that volatile second week of August, for example, some small companies saw their share prices collapse 15%, 20% and even 30% or more, sometimes falling more than three times what the market averages fell. Think about that for a second: if the economy is really rolling over, does a small company suffer three times as much as a large company? Probably not. In fact, a small company can likely adjust its expenses faster than a big company, so may even be able to handle a downturn better. It will of course help if the small company is also debt free. If you are a buyer, then, use that small-cap illiquidity to your advantage during market panics.

The [above] rules should help you survive the next market plunge. There’s no guarantee, of course, other than that – some day – you’re going to get another one!

*http://www.sprott.com/Docs/ViewFromTheStreet/2011/August_23.pdf

Title and Link to Article Referenced Above:

3. How the Dow 30 Stocks Compare According to Their Margins of Safety

Benjamin Graham, known as the father of value investment, is famous for his simple, yet powerful, valuation method as first explained in his 1973 book, Intelligent Investor, and later updated in his book entitled Renaissance of Value. His “Graham Number” approach has been adapted and applied to all 30 stocks listed on the Dow Jones Industrial Index to determine which of the stocks have above average safety factors – of which only 10 do. Below is an explaination of the approach, the formula and the results for all 30 stocks. Words: 1220