By Lim Meng Tat
Director
Russel Investments

THE questions I am most frequently asked at the moment are the following: 'Why do I need to invest in stocks?', 'Is this bear market different to the rest?' and 'Where will markets go from here?'

Human nature dictates that we fear loss more than we appreciate gain. In times such as we have experienced over the last year, this fear often becomes the driving force behind our financial decision-making. Emotion can outweigh reason, and even disciplined long-term investors are challenged by significant questions.

My answer to these issues is simply: focus on the things you can control. Your probability of investment success is influenced more by the things you can control than the performance of investment markets which you can't.

Here are the five factors that you have the power to influence.

• Asset allocation aligned with your goals and risk tolerance

A disciplined approach to staying in the market over time is important but it's staying in the right portfolio - a mix of stocks, bonds and other assets that is aligned with your goals and long-term expectations for risk and return-that is critical.

• Diversification that covers all corners of the markets

While diversification does not assure gains or eliminate the possibility of loss, it can help manage risk by limiting exposure to significantly declining assets. Diversification also prepares us for market recovery. We can't predict where recovery will initiate. It could be small-cap stocks or blue chips, international shares or corporate bonds that rise strongest out of recessionary conditions. To participate fully in a recovery we need to be invested in a diverse mix of assets - owning a bit of everything.

• Rebalancing your portfolio when changes in market leadership cause your allocation to stray from targets

Imagine that on Oct 10, 2007, the most recent stock market peak ,you purposefully had a portfolio of 60 per cent stocks (represented by the S&P 500) and 40 per cent bonds (represented by the Lehman Brothers Aggregate Bond Index). One year later, on Oct 10, 2008, after the S&P had dropped 42 per cent and the Lehman index had fallen 11 per cent, your allocation had changed to 51 per cent bonds and 49 per cent stocks. That's a big shift. It signals a clear need to rebalance to get back to your intended asset allocation. Should asset classes revert to their longer-term mean performance - as they have historically - rebalancing may serve as a measure of risk management and return enhancement. (The indexes used in the accompanying sample cannot be invested in directly. They are simply a proxy for broad markets in each asset.)

• Your investing behaviour

We can't separate emotion from our money but we can be mindful of its influence. Recognise the ongoing tug-of-war between fear and greed as markets cycle in and out of favour and confront the temptations to stray from your chosen investment approach.

• Your plan

When you plan, you are more likely to select from preferred options than to settle for default choices. A documented plan will help you understand what is necessary to make progress towards your goals and how to respond to 'what if?' circumstances.

Why should I stick to stocks?

During periods of swift declines and heightened uncertainty, remaining committed to stocks can be difficult. Negative markets certainly hinder our pursuit of financial security. But historically the number of years with negative returns has been far outweighed by the number of years with positive returns.

When returns are steeply negative, many people equate participating in 'the stock market' with a speculative path to trouble. When returns soar beyond expectation - as in the 29 years since 1930 that the S&P 500 produced returns better than 20 per cent - it's no longer viewed as a speculative gamble; instead it's the opportunity to invest in great companies.

The transition from one extreme to the other is often swift and that is why you can't wait until you're confident in the market's direction before you participate. When waiting for signals that generate confidence, you're doing the equivalent of waiting for prices to go up. This translates into even longer recovery time.

Average returns aren't guaranteed - volatility is

When you work with your financial professional to craft an investment strategy, you do so with certain assumptions based on historical evidence and future outlook. This creates an expectation for the level of returns that the chosen portfolio could produce.

There's one problem with an expectation of average returns: the average return rarely makes an appearance. We may be able to calculate an average number over time but the actual performance of any particular investment from year to year will rarely be near the long-term average. You must prepare for returns that race far ahead of and dive far below average-return expectations.

Consider the accompanying example (see chart) using investment returns from 1973-2007. Here we see that stocks are rarely within a couple of percentage points either way of their average. Most people understand that stock returns generally have a wider dispersion of returns from year to year than do bonds. The common perception is also that bonds have fairly stable consistent returns. But in the example, in the 35-year period from 1973 to 2007 bond returns were close to the long-term average less than one-third of the time. Even utilising a balanced mix of stocks and bonds, such as the 60 per cent stocks/40 per cent bonds example, doesn't fully eliminate fluctuation that varies widely from the long-term average.

Being able to tolerate deviation from the average is the only way to obtain the average over time.

My final tip for investors in this turbulent market is this: amid uncertainty and volatility arises opportunity so speak to your financial professional to help identify your current investment options.

This article was first published in The Business Times.