Reckless decision

NEW YORK – While headlines shouting about a bloodletting on Wall Street might have made many investors wince, those who reacted hastily and sold off their investments could suffer more than headaches.

Though the downturn shouldn’t have come as a huge shock after eight months of unusual placidity in U.S. markets, many mutual fund investors quickly placed sell orders. In the week of the market’s Feb. 27 selloff, when the major stock market indexes surrendered their gains for the year, investors pulled an estimated $3.84 billion from global mutual funds that invest in stocks and dumped $1.35 billion into bond funds, according to Trim Tabs Investment Research.

Tim Swanson, chief investment officer of National City’s private client group, said investors should be careful to avoid letting emotion sway their thinking about whether to hold on to a fund because rash decisions often lead to poor returns. In the latest period, even areas of relative safety such as large capitalization stocks that pay dividends were hit, though not as much as riskier investments such as those in emerging markets.

“If you’re going to invest on the basis of emotion, make sure you stand on your head before you act,” he said, suggesting investors try to do the opposite of what their gut tells them.

The urge to flee was understandable. Feb. 27 saw the Dow Jones industrials lose 416 points by the close and marked the steepest drop since trading resumed after the Sept. 11, 2001 terrorist attacks. But investors should remember volatility often nudges its way into the stock market.

But selling can work against investors, particularly those employing dollar cost averaging, which is the practice of investing regularly regardless of market conditions.

“You’re getting paid for stomaching the volatility. That’s the way it’s supposed to be,” said Swanson. He said stock market investors had grown complacent in expecting the high returns of stocks with the stability of bonds.

“As I look at the past nine months, what was normal and what was the aberration? The first eight months were the aberration,” he said, noting volatility should be expected.

But the arrival of volatility also provides opportunity for bargain hunting and for investors to re-evaluate their portfolios and investment goals.

Paul Herbert, an analyst at investment research provider Morningstar Inc. said investors should try not to place too much emphasis on short-term returns and need to bear in mind the gains reaped in recent years.

“You’ve done well if you’ve been in stocks in the past few years. Maybe people lost sight of the fact that there was some risk to owning stocks. You can be sure that the market is going to remind you of that,” Herbert said.

But even managers of funds that benefited from the rush to safety note that a balanced and diversified portfolio is investors’ best bet in weathering stock market volatility.