Should you bolt from your stocks and stock mutual funds?
Perhaps you've been tempted lately as the stock market has plunged repeatedly since mid July. Virtually everything you own--whether you invest in U.S. stocks or those overseas--has probably plunged during the last four weeks. The average mutual fund that invests in U.S. stocks, has lost about 7 percent, and the average fund that invests around the world is down about 8.7 percent, according to Lipper Inc.
You are paying the price of angst, which is sweeping the globe--an outgrowth of the U.S. housing recession and the crumbling securities Wall Street created based mortgage payments. With the nervousness, the Dow--which hit a high over 14,000 in July--dipped below 13,000 recently.
Some analysts think the worst is over and investors will calm down as they see the end of missteps with exotic mortgage-related securities. Others think the housing recession, and the strain on lenders, will weigh on the global economy well into 2008.
So what do you do with your investments?
Financial advisers say that if you have a well-conceived mixture of stock and bond mutual funds, you should be fine over time--even if the next few months continue to spill red ink onto your savings. The idea is that the economy and the stock market go through cycles, and always come through scary periods--just as they did after the recession that followed the 2001 terrorist attacks. And investors that stay the course are positioned to benefit when the good times return without warning.
The trouble is that most Americans build their 401(k)'s, IRAs and college savings willy-nilly--with no clear idea why they select the funds they select. So at times like these they aren't sure whether they will weather the storm.
So here's how to think your way through it.
Start by focusing on the money you will need during the next year. Maybe it's savings for a house down payment, a car, this year's college tuition, or spending money if you are retired. That money should not be invested in stocks or stock mutual funds. It should be safe in a money market fund, CDs or U.S. Treasuries that will mature by the time you need to get your hands on it. This is a good practice whether the stock market appears strong or weak, because losing periods in the stock market occur from time to time, without warning.
In fact, Ross Levin, a Minneapolis financial planner, tells his retired clients to keep three years of spending money available this way so that they can tap it even if the stock market sours for a couple of years.
It has been rare for the stock market to stay down for more than three years, but it has happened. Between 2000 and 2002, the Standard & Poor's 500--which is roughly referred to as "the stock market"--fell 49 percent and didn't recover completely until this year. But investors who had put about 60 percent of their money in stocks and 40 percent in bonds would have recovered in about two years. That's the reason for a thoughtful mixture of stock and bond mutual funds.
But what's a thoughtful mixture?
The 60:40 mixture is a classic approach for a person who is moderately conservative. A person in their 20s and 30s can take more chances with stocks in retirement savings because they have 30 or 40 years before they will need to tap the money. Financial advisers often suggest young investors invest 90 percent to 80 percent in stocks as long as the person doesn't panic at times like the present and yank the money out of the stock market.
The fear is that if they do, their money won't get a chance to heal when the inevitable downturn comes without warning.
Instead of fleeing from bad times, advisers suggest keeping a constant mixture of funds so that one or two are rising while others are falling. For example, the average U.S. bond fund climbed 1.5 percent the last four weeks while the average U.S. stock fund dropped 7 percent. But over the last year, the average mutual fund that invests in large stocks climbed about 4.26 percent while the average bond fund climbed only 0.97 percent.
Since winners and losers are always changing, it's the total mixture that works over time. Besides using stock and bond funds, advisers often suggest dividing up the stock portion--perhaps putting about 75 percent into U.S. stock funds and about 25 percent into international stock funds. Within the U.S. stock portion, investors can put about 70 percent into a large-cap stock fund that invests in large companies like Microsoft Corp. or General Electric Co. and divide the remaining 30 percent half and half--half into a fund or funds that invest in small companies, or small caps, and the other half into medium-size companies or mid-caps.
Then they suggest keeping the portions constant through good times and bad in the market.
If you have been doing this, there is no need to make a change now. But if you are like most Americans, you have been inattentive, and you might be over-exposed now to funds that invest in small-company stocks, real estate companies, emerging markets, or developing international markets in places like Asia and Latin America.
Consequently, you could be losing more money than you would if you had paid attention.
If you have a small-cap fund it has been a tremendous winner for five years--climbing about 16 percent a year on average. But while you might think that's a sign of strength, it's your warning to consider cutting back. Overly popular funds get expensive, and fall during times of stress in the market. That's been happening. Small-cap funds are falling the hardest--the average small-cap fund has dropped about 10.5 percent in four weeks, according to Lipper.
That does not mean you should bail out of it completely, says John Eckel, a Simsbury, Conn., financial planner. But perhaps you should cut back. Eckel's clients have about 15 percent of their portfolio in small-cap funds now. He thinks that small caps will be weaker than large companies during the foreseeable future because the stocks are expensive and tend to be less profitable than large companies when the U.S. economy is slowing.
So he is whittling exposure to small caps down to 10 percent of a client's portfolio. He's not doing this instantly. He is waiting for a rally in the stock market that carries small-company stocks up about 5 percent. Then he plans to sell at a favorable price. Also, even though a rising market might make it tempting to hold onto the small-company stocks, he won't change his mind because he has a solid reason for his actions.
He says he would do the same thing if a client came to him with more than 5 percent to 10 percent of their money invested in "emerging-market" funds.
These international funds also have been hot for years, which means they could fall the hardest at times of nervousness in the market.
Chicago financial planner Sue Stevens says another vulnerable area is likely to be REITs, or real estate funds. They have been powerful moneymakers over the last five years--climbing about 20 percent on average a year. That's a warning that they have become pricey and could fall hard, especially if a slowing economy causes tenants to resist rent increases in office buildings and shopping centers, or if fewer people stay in hotels.
"I never want people to have more than 10 percent of their money invested in a single sector of the economy," said Stevens. "So if they now have 30 percent of their money in REITs they are taking chances like they were when they held too much technology in 2000."
Ideally, people cut back on high-flyers before downturns like the present one. For example, Stevens was cutting back on small-cap stocks and REITs months ago because they were consuming too large a portion of her clients' funds. She was also moving money out of so-called "value funds," which typically invest in cheap stocks. The popularity of some value stocks over the last five years has made some overly expensive. So Stevens says she moved some money out of small- and large-cap value funds and put it into small- and large-cap growth funds. About 15 percent of the money in each of the categories is now focused on growth stocks, which are relatively inexpensive. She says she added the money to Marsico 21st Century, Wintergreen and Champlain Small Company funds.
Gail MarksJarvis is a Your Money columnist and the author of "Saving for Retirement Without Living Like a Pauper or Winning the Lottery." Contact her at email@example.com.Copyright © 2015, Los Angeles Times