Portfolio Strategies For A Frightening Time
That strategy is terrific for people who have plenty of time to wait for the market to rebound. But some people need their money to work for them sooner rather than later. The market's recent pullback -- the S&P 500, Nasdaq and Dow Jones Industrial Average are down 12 percent, 20 percent and 8 percent, respectively, in 2001 -- only adds to their sense of urgency. Should they run screaming from the stock market? And if so, where should they run?
Our view is that cool heads must always prevail. But, as we demonstrate below, that can mean different things to people with different investing horizons.
The Sunset Gazers
If you're retired or are planning to retire in the next few years, you're probably the most vulnerable to a sustained bear market. You're likely to be sitting on a big chunk of financial assets -- assets that seem to be losing value every day. That beachfront condo in Boca Raton you've been eyeing could be in jeopardy if you don't take a good hard look at your portfolio allocation.
While it's universally accepted that people nearing their golden years should adopt income and capital preservation as their primary investment strategy, many have strayed from that discipline in recent years. The intoxicating bull market for growth stocks over the past seven years made utility stocks and bond funds look drab. That often prompted older investors to divert larger portions of their net eggs into higher-risk, higher-return holdings. Or the shift may have happened unintentionally, as the stronger performance of riskier stocks meant they took steadily higher weightings in many portfolios. But whether the added risk was shouldered intentionally or by default, it may now look like a mistake.
With a limited investing horizon and the market in the dumps, what should you do to rectify it?
Regardless of how much an older investor has already lost, David Feldman, a certified financial planner with Wechter Financial Services in Parsippany, N.J., urges anyone looking to retire soon to start paring back excess equity exposure. "No one knows where the bottom is going to be," he says. "It's better to take a reasoned loss than to be subject to a downward spiral whose end no one can pinpoint."
The conventional wisdom says a good equity allocation is a percentage equal to 100 minus your age. For an investor in his or her early 60s, Feldman recommends a 50 percent to 60 percent weighting in cash and bonds -- specifically money-market instruments and multisector bond funds consisting of government and high-grade corporate debt. The remaining money should be devoted to equity mutual funds, with the goal of diversifying risk across several sectors.
That's a bit too austere for Robin Tull, a certified financial planner with R.W. Tull & Associates. "I can't justify big selling in a time like this," he says. "Retirement still leaves some room for a long-term outlook." Tull recommends that prospective retirees sit down and calculate their monthly spending needs and set aside 18 to 24 months of cash. "Rebalancing is a good thing -- but pulling out of stocks altogether is really for someone who just can't stand the idea of having money in the market. For me, there are still too many positive reasons to stay in the market."
No matter which end of the spectrum your beliefs fall, one thing is clear: It's time to reevaluate your portfolio, before this bear takes a bigger bite out of your nest egg than you're comfortable with. Our short-term risk worksheet can help you determine your proper asset allocation based on your investment horizon, portfolio size, the urgency of your goal (can it be pushed off a year or two?) and the rate at which the cost of your goal is rising. If retirement is at hand or came five years ago, you'll probably prefer our asset allocator for retirees.
Whatever you do, don't forget to think about the tax man. Despite the advent of the bear, the long bull market has still left many investors with significant gains. Dumping those holdings (from nonretirement portfolios) could have a dramatic effect on your 2001 taxes. Conversely, taking some losses in taxable accounts now could give you a tax break on next year's returns.
If you do decide to make some changes to your portfolio, you may be tempted to wait for one of the inevitable rallies that we're bound to see over the next few weeks before selling. Don't wait too long, cautions planner Dee Lee of Harvard, Mass. Asset allocation ultimately has a much bigger impact on your returns than a bit of (chancy) market timing could. If your allocation is out of whack, you should focus instead on getting yourself into the right investment vehicles as quickly as possible.
For more on short-term investing, visit SmartMoney University.
The 'Tweeners
Those college-tuition bills are just a few years off. Or your daughter's boyfriend just asked her to marry him, and they're planning a big wedding next June. Or you've been saving and investing in hopes of buying your first home in a couple of years.
If you've got a short-term financial goal on the horizon, the current market probably instills one emotion in you: Terror. After all, it's unsettling enough to watch your 401(k) implode, even when retirement is still 20 years away. But it's nothing like suddenly realizing that Junior's college options have been whittled down from Mercedes U. to Hyundai State.
Like our soon-to-be-retireds, many middle-aged investors with short-term goals have been lured into highly aggressive positions by the extended bull market. And now that it looks as if this bear could be settling in for a while, they aren't sure how to get their portfolios back on track.
What to do? First, take a step back and reexamine your short-term -- nonretirement -- portfolio. To meet a relatively imminent financial goal, you need income-producing investments -- not tech stocks, says Lee. For goals that are only a year off, that means a heavy emphasis on money-market funds and CDs. If you still have a few years to go, it means individual bonds or low-risk, income-producing stocks. This way, "even if the market is heading in the wrong direction, their portfolios shouldn't be," she says.
Take a look at our short-term risk worksheet. If you find that your current investments are simply too risky given your time frame, you need to rebalance your portfolio. This can make for some ugly decisions -- do you sell Cisco Systems (CSCO) at a loss? If it's the only way to correct your asset allocation, you should indeed, says Lee. Otherwise, try to sell companies or funds that you've truly lost faith in.
Ask yourself if you would buy that stock (or fund) again today. If the answer is no, that's what you should sell, says CPA Laurence Foster of New York City's Richard A. Eisner & Company. It's better to take a loss now than have a thoroughly painful talk with junior later.
The Whippersnappers
What if you're single, under 30 and have few expenses or financial obligations? Let's say you're a model investor. You max out your company 401(k), contribute to a Roth IRA every year and even have money left over for a regular brokerage account, which you've been using to build a down payment for a car.
With a long-term investment horizon, you've taken some big risks on tech stocks. Now, those risks are coming back to bite you. Should you panic and rush for the exits?
Heck no. As a relative youngster, you've got plenty of time until retirement and can afford to ride out the storm with an aggressive investment outlook. But you may not want to be quite as aggressive as you have been in the past. Even investors with a high-risk tolerance should have a small percentage of bonds and cash, says Gary Schatsky, chairman of the National Association of Personal Financial Advisors. To find out what your optimal mix of stocks, bonds and cash should be, check out our asset allocator.
Don't make the mistake of thinking that the concept of asset allocation doesn't apply to you just because you're a twentysomething. According to a 2000 study by Ibbotson Associates, as much as 90 percent of an investor's returns can be attributed to asset allocation rather than the specific stocks and bonds held. By spreading your portfolio across different asset classes, for example, you may have been able to cushion your losses over the past year. Had you moved all your tech holdings into bonds or money-market funds, you might still be adding to your bottom line.
Of course, you probably didn't have that kind of foresight -- few people do. But even if you've ridden the bear all the way down, keep this in mind: For the long-term investor, a market downturn is a perfect time to buy.
"For those who are receiving money that they can invest, or those who have been sitting on the sidelines and have too much money in cash, now is a wonderful time to be jumping in on the action," says Schatsky.
Just be sure to do your research. The days of rising waters lifting all boats are over, at least for now.
