Last Monday's dramatic market downturn punctured the illusion of endlessly rising stock values. So, what do you do now? Stay invested? Get out of the market? Shift to "safer" investments?
Each person's situation is different, so there's no simple answer. Here is a discussion of key issues.
Just how serious has the recent downturn been?
"It was a normal market correction," says Arnold Kaufman, editor of The Outlook, a financial report published by Standard & Poor's Corp. A "correction," typically means a loss of 5 to 15 percent of market valuation, often in just a few days. A more serious "bear market" means, by one definition, a loss of more than 15 percent, often over a longer period of time. As of this writing, the Standard & Poor 500 index and the Dow Jones industrial average are each down about 10 percent from their highs. The correction is most pronounced among technology stocks. The Nasdaq composite index, weighted in that sector, is down about 15 percent.
Could we be entering a "bear market?"
"The jury is out," Mr. Kaufman says. He believes the market is stabilizing. Still, some technicians worry that indexes could drop on difficult news, such as disappointing corporate earnings or an interest-rate hike later this year. Higher rates inhibit corporate profits, thus driving down stock prices. Bear markets are infrequent. But there have been 14 since World War II (see chart).
Is it safe to buy stocks again?
That depends on your risk tolerance. Some very good stocks are now much cheaper to buy, Kaufman says. "One should be very careful," says Gene Jay Seagle, president of Tactics & Technics, a market consulting firm in Weston, Conn. He likes companies with proven value.
Should I get out of the stock market?
Not according to studies by Ibbotson Associates, a Chicago-based financial information firm. Despite market ups and downs, stocks historically provide the greatest return of profit over time, exceeding bonds, bank accounts, and precious metals. "Market timing" - pulling out when the market is headed down and getting back in before it jumps back up - is notoriously difficult. And, if your money is not in a retirement account, capital-gains taxes must be reckoned with when you move money around.
What should I do right now?
Rethink your long-range investment priorities, says Tim Schlindwein, a principal at Schlindwein Associates LLC., a financial consulting firm in Chicago. Identify your investment goals; determine what portion of your assets is in stocks and what portion you might want to have there in the future. Make certain your stocks or mutual funds are diversified among various industries and types, including possibly fixed-income and international funds. Diversification helps offset risk.
Should I change my plan if there's more market turbulence?
No, says John Markese, president of the American Association of Individual Investors a small-investors' group in Chicago. Minor modifications may make sense. But individuals should invest for the long haul, he says.
What if I'm about to retire? Should I "cash out" of stocks?
You likely have many years of life left, Dr. Markese says. Granted, he says, you don't have as much latitude for risk. But leaving as much money as possible in stocks over time will allow you to boost total return.
Do any stock sectors look promising?
Kaufman still likes selected high-tech stocks. Rao Chalasani, chief investment strategist at Everen Securities Inc. in Chicago, recommends cyclical stocks, such as aluminum companies, auto firms, and some department stores; and, for the bold of heart, he too likes technology firms. "Defensive plays," he says, include real estate investment trusts (REITs), and utilities.
How do I start to reinvest? A lump sum or smaller amounts invested periodically?
Investing small amounts over time - known as dollar-cost averaging - is considered the safest approach. It protects you from buying too many shares at a market peak.
Should I be moving my money into bank certificates of deposit or money-market mutual funds?
Bank CDs are federally insured up to $100,000, thus providing a high degree of safety. But CDs have a locked-in interest rate, which may not offset higher inflation.
Money-market funds are not federally insured. But their yield is set on a daily basis. Top money funds now have a yield of about 5.75 percent, says Chip Norton of IBC Financial Data Inc. in Ashland, Mass. The average yield on a taxable money fund is 4.78 percent, Mr. Norton says, compared with 4.60 percent on six-month CDs. One-year CDs are fairly attractive, he says, paying about 4.92 percent. The disadvantage is that you are locked in. In the past three weeks, more than $14 billion has poured into money funds.
What about moving money from stocks into bonds?
Locking into long-term bonds could be risky, experts says, given the possibility of rate hikes.
Still, conservative investors might want to consider intermediate-term (maturing in five years or so) bonds. Grade AAA corporates pay about 7 percent interest, says Roger Conrad of KCI Communications Inc., an information firm in Alexandria, Va. Investors who want current income might also consider REITs and utility or oil stocks.
Finally, experts note, some mutual funds are designed to benefit from downturns. These "contrarian" funds, which rely partly on futures and options strategies, include the Robertson Stephens Contrarian Fund and Rydex URSA Fund. But some contrarian funds did get hurt last week.