What an Investor Can Do When the Market Is Scary
MUTUAL-FUND investors barely had a chance to revel in last year's boom before a new year's surprise arrived: The financial markets headed south.
By the close of a cheery stock market Friday, the Dow Jones industrial average had more than recovered. It was up 1.32 percent so far this year. But the Nasdaq composite was still off 3.2 percent for the year, and the Standard & Poor's 500 stock index was down 0.67 percent.
To shareholders who are getting concerned - possibly enough to consider retrieving their money before things get worse - many financial experts give this simple advice: Sit tight.
"Most retail investors make their biggest mistake by trying to time the market," says Porter Morgan, senior vice president and investment strategist for Liberty Financial Associates, a Boston-based mutual-fund company.
"You're just as likely to be wrong and miss another good year in the market as you are to be right by trying to go to cash," he adds.
His view is echoed by many market watchers, who extol the benefits of staying invested for a long time. Still, they suggest a few general options for people who are concerned about losses:
*Reconsider risk. "At the beginning of the year, everybody ought to sit down and they ought to ... find out what is the risk level of their investment," says Sheldon Jacobs, a mutual-fund adviser and newsletter publisher in Irvington, N. Y. You should assess what level of risk is appropriate for you, he says, and restructure your portfolio accordingly.
Part of this process may be to revisit asset allocation - how much you hold, for instance, in bonds vs. stocks, and in domestic vs. foreign stocks.
*Shift stock funds. Some stock mutual funds are managed more conservatively than are others, and shifting to them can be a good way to moderate losses in a bear or down market, according to Value Line Inc., a New York-based mutual-fund rating firm.
Such funds include balanced funds, which invest in a combination of both stocks and bonds, and equity-income funds, which invest in stocks that pay high dividends, and thus have a buffer during market setbacks.
"I like the income equities for a good defensive strategy," says Colette Coffman of Value Line. "They historically have weathered bear markets and crashes well."
The downside of these more conservative funds, however, is that they tend to underperform when the market is good. But for those who are concerned about protecting their money, "equity-income investing should preserve capital in most down markets," says Edward Bousa, who manages the Putnam Equity Income Fund in Boston.
*Invest in bonds. Given the current volatility of the stock market, bonds may be a more favorable investment than equities, some experts say. "For the really scared investor who doesn't want to take much risk at all, bonds appear to be a very good bet at this moment," Mr. Morgan notes. He says it is unlikely that interest rates "will increase very much, so you shouldn't see any loss of principal," he says.
*Invest in utilities. Some market watchers sing this stock sector's praises. With interest rates expected to remain low, "utilities are a defensive vehicle that should outperform," says David Calabro, lead manager of the Massachusetts Financial Services Total Return fund, a balanced fund, in Boston. Still, utilities vary in type and risk, and you should find out exactly what kind a fund is invested in. Equity-income funds, for example, often have sizeable utility holdings, notes John Cammack, a vice president at T. Rowe Price Associates, a fund company in Baltimore.
*Look overseas. Emerging markets in foreign countries, like those in Asia, have a lot of potential right now, many advisers say. Although not really a defensive or low-risk position, overseas investments offer diversity and don't necessarily move in tandem with domestic markets. Morgan of Liberty says he thinks that foreign markets will "outperform the US [markets] this year."
*Jump ship. Investors who need their money in the next year or two for a big expense, like a house or college, should get out of the stock market says Kurt Brouwer of Brouwer & Janachowski, an investment-advisory firm in San Francisco. Other advisers agree.
Short-term needs aside, pulling your money out of a fund has two major disadvantages, notes Mr. Brouwer. First, capital-gains taxes might be more than the possible losses related to staying in the market. Second, he cautions, once you get out, you may never get back in because the market may never look good enough. (In addition, expenses for transaction costs, and, with some mutual funds, early withdrawal fees, can also hike the cost of redeeming shares.)
Alternatively, some skittish investors will shift their assets to a money-market fund in the same fund family.
But in 1996, shareholders may not have to worry as much as they think. Historically, says Morgan, the year after a major advance is usually a good one. He says that in five of the seven other times since the 1920s when the market increased 35 percent or more, the subsequent year yielded "additional gains averaging 18 percent."