Should I React to the Market Pullback?

As I write this article, the stock market appears headed for a fifth consecutive day of losses. The Dow Jones Industrial Average is down over 200 points; the VIX (an indicator of market volatility) is up. The folks at CNBC (which is on in the background) are analyzing the market to death.

The short answer to the question asked in the title of this article is no. As always, a little perspective is a good starting point.

--The S&P 500 Index closed at 677 on March 9, 2009. This was the bottom of the 2008-09 bear market.

--The index ended the first quarter of 2012 at 1,408, representing an increase of 108 percent from the March 9, 2009 low point.

--As I write, this the index has declined from the quarter-end level to about 1,362.

--After losing 13.57 percent in the third quarter of 2011, the index has put together two very solid quarters, with gains of 11.82 percent and 12.59 percent, respectively.

In short, the stock market has been on a tear the past couple of quarters, and for that matter for the past three years. This increase has not been a straight, steady ride, as there were periods of sharp decline in 2010 as well as the previously mentioned results for the third quarter of 2011.

As I wrote here a few weeks ago, investors shouldn't get euphoric when the market rallies. Likewise, a drop like we are seeing over the first couple of weeks of the new quarter is nothing for long-term investors to panic about.

I have no idea if this market decline will end at five days or if it has a bit further to run. It amazes me that just a few days ago, the overwhelming majority of the guests on CNBC were talking about the current market environment as a "once in a generation" buying opportunity for stocks. Now the focus seems to be on what to do now to avoid the impact of the market downturn.

What I suggest is nothing new to readers of my past Smarter Investor posts.

Rebalance your portfolio. More than likely, your allocation to stocks is higher than your target allocation. If the allocation is outside of your target allocation (which might be something like a range of +/- 5 percent of your target allocation), you will want to rebalance back to the target or at least to a point within your target range. Even if the allocation is still within the target band, you might want to rebalance back to the midpoint of the target range. It is my firm belief that the amount of risk that you are taking with your investments should be your first priority. An over-allocation to stocks by definition means an increase in portfolio risk.

Fall back on your financial plan. This goes hand in glove with rebalancing your portfolio. In my opinion, it is more important to track your progress toward your financial goals than to worry about how your investments have performed relative to any market benchmarks. Adjust your allocation if you are well ahead toward your goals (perhaps you might lighten up on your risk level). Likewise, you may need to adjust your strategy if you are behind in your progress. You might consider taking more risk or saving more if you can.

In short, don't react to moves in the market. Fall back on your financial plan. Control what you can control, namely your investment allocation and the level of risk that you are taking with your investments.

Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides advice to individual clients, retirement plan sponsors, foundations, and endowments. Read more about Roger here.

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