This Might Be a Good Time to Evaluate Your Portfolio

Investors who have enjoyed Wall Street’s longest and strongest bull market for more than a decade may well wonder where to go now in the aftermath of recent sharp declines in stock prices. Many analysts now say the bull market faces its biggest threat in years.

Is it time to sell? If you do sell, what are you supposed to do with your money? A question-and-answer look:

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Q. Why are analysts suddenly so negative?

A. Several reasons, says Michael Metz, market strategist at Oppenheimer & Co. in New York. The stock market had been buoyed by an extended period of low interest rates, low inflation, steady but unspectacular economic growth, rapidly rising corporate earnings and a huge influx of newly invested cash.

Now, commodity prices and wages appear to be rising sharply, which could indicate that inflation is back. Interest rates appear headed higher. Companies are reporting lower-than-expected earnings, and investors are pulling back--investing less of their cash in stocks.

“I think the market is going to suffer from malnutrition,” Metz says.

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Q. What does that mean?

A. The stock market may suffer from an extended period--anywhere from a few months to a few years--of declining or flat prices, analysts say.

Of course, analysts are sometimes wrong. The market may well rebound from this in the same way it’s rallied from many other setbacks of the last few years. Many investors will view the latest sell-off as a buying opportunity.

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Q. OK, but I’m still worried. Does that mean I ought to get out?

A. Not if you have a reasoned investment plan, where the portion of your assets that are in stocks are there to address your long-term goals. Since 1926, stocks have rung up an average annual return of 10.5%, according to Ibbotson Associates, a Chicago-based market research firm. That’s substantially better than any other type of traditional investment.

The fact that stocks have performed far better than the average lately--over the last five years stocks have appreciated an average of 16.57% per year--is somewhat ominous for near-term returns. But, for those who aren’t looking to cash out in the near term, they’re still likely to generate fairly generous long-term results.

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Q. What if I don’t have an investment plan?

A. Then now’s the time to formulate one, says Robert Cummisford, senior consultant at Ibbotson. You should consider how much of your savings should be invested in stocks, bonds and cash, as well as whether you can handle investing in foreign stock and bond markets.

This process is referred to as “asset allocation” and it generally involves diversifying your holdings by putting a little bit of money in several things. Generally speaking, those who are young and affluent can put a greater percentage of their assets in stocks and international investments, while those who are older or less tolerant of risk should keep a greater portion of their assets in cash.

If you don’t know how to formulate an investment plan on your own, consider hiring a financial advisor to help you.

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Q. My stocks have fallen so sharply that I’m wondering if it’s too late to sell. Shouldn’t I just hold on until stock prices recover?

A. If you think the companies you own are valuable and that their stock is still likely to appreciate, by all means hang on. However, you should periodically evaluate your investments to be sure you would still buy the same stocks today. Get a Value Line investment report on the companies you own--these reports are usually available through brokers or in libraries--and take a look at how your companies’ current price-earnings ratios and dividend yields compare to their historic averages.

If these key numbers are far different today than they have been historically--the yields lower, the price-earnings ratio higher--ask yourself if the company is set to exhibit unusually strong growth in sales and earnings. If not, there’s a good chance that your investment will decline in value or simply languish. If that’s the case, you’re better off selling your stock and investing the money in something that will generate better returns.

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Q. I invest through mutual funds. What do I do?

A. Just like the investor who buys individual stocks, you should be asking yourself if you would buy the same funds today. Are you happy with the way your fund manager handles the portfolio? Are you comfortable with the risks he or she is taking? If so, hang on. If not, find yourself another mutual fund.

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Q. Are you saying to get out of the stock market entirely?

A. Never. Stocks remain a good long-term investment. However, analysts stress that tough markets require a high degree of selectivity. If you choose stock or mutual funds carefully--choosing companies with strong balance sheets and good earnings prospects--you could do as well in a bad market as you did in a strong one.

However, you should be careful about investing in “hot” or speculative issues--companies that have yet to report earnings or dividends but are popular because of their market niche--because these companies are particularly likely to suffer when the market’s mood turns sour.

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Q. I’m becoming increasingly uncomfortable with stocks, but where can I earn a decent return on my money?

A. Some analysts are recommending that investors take another look at corporate and government bonds. Some municipal bonds, for instance, are earning taxable-equivalent yields exceeding 8%--as are many high-grade corporate bond issues. In addition, there’s no sin in parking money in cash investments--such as those dull old 5% savings accounts--until you feel more comfortable about stock values.

Don’t stick with cash too long, however. Over long periods, returns on cash-oriented investments tend to grow more slowly, after-tax, than the rate of inflation. That leaves you in the unenviable position of having less buying power tomorrow than you would have enjoyed if you spent the money today.