Protect your investments: Maintain appropriate asset allocation in market downturn and upswing

Key Points

With the worst January performance in the history of the stock market behind us, what now? Are we headed for (or already in) a major recession, or is this just another of those predictable bumps in the economic road to financial security?

Since it's impossible to predict the future, no one knows for sure. So, what do you do now to protect your investments? Should you just sit tight and wait for the inevitable recovery, or should you consider strategic changes in your portfolio?

In my view, the smartest thing that savers and investors can do in times like these is to follow the course that has always proven to be the safest in the past.

Don't panic

First, and arguably most important, don't panic. Your most valuable economic insurance policy is the current earning power of your business, your job, or your professional practice.

With enough current income to sustain your lifestyle, you're in a position to avoid the most common error made by individual investors - panic-selling when the market is falling to new lows. Human nature being what it is, many people wind up selling during market lows and buying during market highs - a deadly investing error.

Now is the time to ask yourself whether our economy is going to turn around during your investing lifetime. If you believe that it will rebound as it always has in the past, then short-term bumps in the road shouldn't be a matter of concern.

History of lows

America's first financial crisis was the Panic of 1819. Like those that followed, it featured widespread foreclosures, bank failures, unemployment and a slump in agriculture and manufacturing.

As severe and long-lasting as it was, the crisis proved to be temporary. By 1824, the rebound had begun.

From the Panic of 1819 to the beginning of the Great Depression in 1929, there were at least eight severe recessions or depressions in the American economy, all of which were followed by sharp recoveries and, in most cases, new market highs.

Since the end of the Great Depression in the late 1930s, disruptions in our economy have been generally milder and of far shorter duration.

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 a study by Ned Davis Research, we haven't had a recession lasting longer than eight months.

The Post-Korean War Recession of 1953 was over in about a year. Other recessions include the 1973 oil crisis, recessions in 1979, 1987 and, of course, the short-lived market dive following the September 11 attacks in 2001.

Without exception, all of the economic disruptions following the Great Depression have been of relatively short duration, followed by sharp economic growth and new market highs.

These market downturns have consistently proven to be the times when it was most beneficial to invest. Ironically, fear keeps most people from investing during a downturn or a recession (with the notable exception of Warren Buffet, generally regarded as the world's most successful investor).

Of course, there is only one Warren Buffet, and most of us lack his insight and courage when it comes to personal investing. For the rest of us, a more conservative approach is probably more appropriate.