How to Overcome a Tough Market Environment

"Don't just do something, stand there!"

Those words of wisdom have been attributed to everyone from Clint Eastwood to Alice in Wonderland's White Rabbit. But whatever their provenance, they can be incredibly useful, especially when it comes to your investments.

After all, the whole point of setting up a sensible asset-allocation framework and populating it with sturdy investments is so that your portfolio can hold up in varying market conditions and doesn't need babysitting. Meanwhile, volatile markets can be a breeding ground for knee-jerk investment decisions motivated by emotions more than fundamentals; undertaking a major portfolio renovation in such trying times is usually not a good idea.

That said, tough markets have a way of making us feel powerless--as though important parts of our futures, whether our retirement dates or our kids' college choices, are out of our hands. To regain a sense of control, it's natural to want to do something, anything.

Morningstar.com site editor Jason Stipp outlined some productive ideas for investors who want to take back control in this article--they include checking up on your portfolio's asset allocation and the adequacy of your liquid reserves, as well as staying attuned to potential bargains that can crop up when market participants overshoot on the downside. (And they reliably do.)

But I'd add one more item to the to-do list for investors seeking control in uncertain times: Go for the sure things. No, I don't mean to pull all of your money out of stocks and bonds and steer them toward FDIC-insured instruments. Cash is the right choice for short-term spending needs, but it's a guaranteed money-loser for longer time frames once inflation is factored in. Instead, I mean increasing your investment contributions if you're still accumulating assets for retirement and reducing your spending if you're retired. Working to reduce your investment-related costs--including your tax costs--is another "sure thing" way to improve your portfolio's long-run results even if the market isn't cooperative over your holding period.

Higher Contributions More Than Offset Weak Market Returns Saving more and/or spending less during weak markets appeals on an emotional level, as we humans naturally tend to want to spend more when we're feeling flush (the so-called "wealth effect") and conserve resources when they're scarce. Moreover, changes to savings and spending habits needn't be radical to have an impact. For example, an investor who socks away $100 a month for 30 years and earns a generous 7% return will have more than $122,000 at the end of that time period. But the investor who earns just a 5% return but makes larger ongoing investments of $150 a month will have nearly $125,000 30 years later. Ideally, you'd do the higher contribution amount AND earn the higher return, but the higher contribution rate is within your control; the market's return isn't.

The math works the same for retirees who are actively withdrawing from their portfolios: Even modest adjustments to their spending rates during tough markets can greatly improve their portfolios' sustainability. A T. Rowe Price study following the bear market demonstrated how retirees using the 4% rule to guide their withdrawals but forgoing inflation adjustments during weak market years would have greatly improved the long-run sustainability of their portfolios. Alternatively, retirees could tether their withdrawals to their portfolios' performance by withdrawing a fixed percentage per year, bounded by a "ceiling" and "floor," as discussed in this Vanguard research.

Managing Costs Helps, Too Of course, saving more and spending less might seem like pure drudgery. The good news is that they're not the only surefire ways to improve your portfolio's results in a tough market. Controlling the full spectrum of costs you pay--both direct investment costs as well as tax costs--also works to boost your portfolio's return potential without requiring you to engage in any fancy (and potentially unsuccessful) market machinations.

Assuming you haven't already done so, you can also improve your portfolio's return potential by dumping any investments that charge more than 1% and swapping into lower-cost alternatives such as index funds and exchange-traded funds, which can be had for just a tiny fraction of that amount. There's no guarantee that the low-cost investments will outperform the higher-cost ones, but Morningstar data demonstrate that low costs are the best predictor of a fund's success or failure. Minding your own trading activity with an eye toward reducing the drag of brokerage commissions is another way to enhance your take-home results. Finally, tax management is another easy way for investors to seize control in uncertain times. Investors can reduce the drag of taxes by taking full advantage of tax-sheltered vehicles when they're accumulating, paying attention to which types of assets they place in which account types (asset location), and sensible withdrawal sequencing in retirement. The "Minimize Taxes" page on the Personal Finance tab on Morningstar.com includes links to articles and videos about tax management.