Stay the Course During Market Volatility

Bond and stock traders…not investors…have been in shoot-first, ask-questions-later mode, overreacting to Federal Reserve Chm. Ben Bernanke’s recent remark that the Fed may begin tapering off its massive $85-billion-a-month bond buying program later this year. Their knee-jerk reactions have sent financial markets into a tizzy. As a long-term investor, rather than a trader looking to make a buck on short-term movements, don’t get caught up in the frenzy.

FROM KNIGHT KIPLINGER: An Investor's Manifesto

Although higher bond yields and lower bond prices make sense, given the prospect of an improved economy and less bond buying by central bankers, it’s not clear how much higher yields will go — particularly with inflation running so low. The Fed won’t consider raising interest rates until inflation notches higher and unemployment is closer to the 6.5% mark. And when it does start to ratchet up rates, it will do so gradually, over the next two years or so, giving bond investors lots of time to adjust. The days of capital appreciation on bonds are probably behind us, however. So for now, content yourself with clipping the coupons for interest and enjoying the lower volatility of bonds compared with stocks.

However, stocks are a very different story. The eventual withdrawal of the Fed’s stimulus won’t snuff out growth. Indeed, the economic strengthening that will allow Bernanke & Co. to gradually reduce its massive bond buying program is unequivocally good news for stock prices. It’ll help corporate earnings to keep rising, supporting stock prices. The current dip should be seen as a to-be-expected market correction. So far, it’s not even as great as the classic definition of a correction...a decline of 10%.

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So stay with the asset mix that makes sense for you — stocks, bonds, real estate and so on, as appropriate for your age, wealth and tolerance for risk. If loading up on stocks fits with that mix, a further correction is a buying opportunity. Otherwise, pay little heed to the active traders and keep your eye on the longer horizon.