Month: May 2012

For many investors, a high-performance fund is one that zooms ahead of the market. But what is the market?

As a pacesetter for their funds, investors often turn to the performance of a widely used index such as the Dow Jones Industrial Average – the average value of 30 large industrial stocks – or perhaps the S&P 500 index, which includes stocks from 500 leading companies in leading industries. However, these indices aren’t the market and may not be relevant for the individual investor.

Consider the S&P 500 index. Even though the equities are chosen to represent the U.S. economy, the list isn’t comprehensive. There are more than 5,000 stocks listed on the New York Stock Exchange and the S&P actually tracks only a small percentage of these.

Moreover, the S&P 500 is made up of essentially one asset class: large-capitalization companies. So, if your fund contains small-capitalization stocks, the S&P 500 might not be an accurate gauge of its performance.

In fact, the S&P 500 index isn’t always an accurate gauge even for funds that consist mainly of large-capitalization companies, because it isn’t equally weighted. The largest and often most popular stocks account for the majority of the index’s performance. These popular stocks have a weighting several hundred times that of the less popular stocks.

That doesn’t mean you should ignore the S&P 500 and other indices.

However, to use an index as a pacesetter, you might want to ascertain whether its securities are comparable to those in your fund’s portfolio.

As a result of the stock market’s decline during the financial crisis, many investors now worry that even minor downturns are warnings of worse times ahead.

No one can predict when or by how much a security’s value will fluctuate, but you can take steps to protect your portfolio from market volatility.

First, don’t try to time the market. Some investors try to overcome market volatility by jumping in on an upswing and jumping out on a downswing. But even the pros find it difficult – if not impossible – to predict how financial markets will react.

Remember, you have to be right twice: when you sell and when you buy.

Review your asset allocation before you’re tempted to make emotional changes.

Make sure your portfolio is diversified. Although diversification can’t protect you from a loss, it may help cushion your overall portfolio from significant declines.

If you’re still contributing to an account, you may want to invest a fixed amount a little at a time instead of a lump sum all at once.

This strategy for managing risk is called dollar cost averaging.

Because the amount you invest remains constant, you are able to buy more shares of a stock or mutual fund when the price is low and fewer shares as the price rises. Over the entire purchase period, your average cost per share could be lower than the investment’s average price per share.

Stick it out. Although past performance is no guarantee of future results, historically the markets have always rebounded. For the past 10 years ending December 31, 2011, the S&P 500 index gained over the long term, returning 2.92%.

(Note that the S&P 500’s return factors in dividends and is thus higher than it would be without dividends. It is not possible to invest in an index.)