Feeling Sick? It May Be Time to Change Your Diet

As harrowing as the stock market’s decline may have gotten in recent weeks, the last thing most individual investors wanted to do was to sell.

And, of course, most did not--a decision that probably feels better today, with the market having rebounded for three consecutive sessions.

But if you entertained for even a moment the idea of selling some of your stocks or stock mutual funds when prices were tumbling, maybe that notion wasn’t such a bad one. Maybe you should sell something.

Is that heresy? Warren Buffett says the best time to sell a stock is “never”--he’d rather hold good investments forever, weathering their inevitable down periods. That’s noble enough, and Buffett has proved that buy-and-hold works.

But you’re not Warren Buffett. He has $15 billion. Even if he temporarily loses 80% of that in a wicked bear market, he won’t be eating cat food. Small investors can’t necessarily say the same.

When do you sell a stock or stock fund? That’s a two-part issue. The “micro” part--which individual security to sell--will depend on your personal judgment of the investment’s prospects, its value (or lack thereof) and your time horizon.

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The micro decision, however, may only come up once you’ve made the “macro” decision to sell. And that one really isn’t so tough, or shouldn’t be.

John Markese, director of the American Assn. of Individual Investors in Chicago, figures that if the market’s drop this year has “made you nauseous, then you’d better reevaluate your portfolio.”

If you own stock mutual funds, chances are the decline you’ve experienced this year has been minor. Lipper Analytical Services calculates that the average general stock fund has lost about 2% year-to-date. Funds that own smaller, more speculative stocks have suffered worse, while blue-chip stock funds are up slightly for the year.

But it would be wise to consider the market’s March plunge--when it gave back most of January and February’s big gains--a shot across the bow. Do you know how much you might lose in a particular fund, should a true bear market begin?

Daniel Wiener, editor of the Vanguard Advisor fund newsletter in Brooklyn, N.Y., calculates for each fund he follows the maximum loss ever suffered in any down-market period. That at least provides a benchmark for figuring a fund’s relative risk level. If you don’t want to lose a lot in a bear market, you can cut back on or eliminate aggressive funds that dropped sharply in 1990 and 1987--the last bear-market years.

Unfortunately, shareholders of the many funds that have only been around since 1990 don’t have such down-market benchmarks. And maybe it’s just as well. Because if the question is whether you should have less money in the stock market, you should be weighing your entire portfolio--all of your stock funds--against the relative merits of owning other assets as well, such as bonds and money market securities.

Sheldon Jacobs, editor of the No-Load Fund Investor newsletter in Irvington-on-Hudson, N.Y., notes that there’s a big difference between market timing--dumping stocks when you think the market is at a peak and buying when you think they’re bottoming--and periodically adjusting a portfolio simply to match the level of risk you’re truly comfortable with.

Market timing tends to be an either-or decision, and for most people it’s a losing game: No one on Wall Street has ever figured out how to time stocks’ swings perfectly. Most people, in fact, fail miserably at timing.

But trimming back on your stocks or stock funds, and raising your investment in bonds or money market securities as a buffer, doesn’t require you to hazard a guess about the market’s next move. You’ll win if stocks advance again, because you’re still in the market. Just as important, if stocks are primed to sink, you’ll have limited your losses.

Academic studies have demonstrated that asset allocation among stocks, bonds and cash is the key to your portfolio’s performance over time--much more important than the individual securities you select. Over the last 70 years, a portfolio 100% invested in the Standard & Poor’s 500-stock index has returned 10.7% a year, on average. But that investor had to suffer through losses averaging 12% whenever the market dipped.

In contrast, a portfolio 60% invested in the S&P; and 40% invested in long-term Treasury bonds has returned 8.9% a year, on average, while losing a much more modest 8% in the typical down market.

History never repeats exactly, but if you’re mulling the selling-adjusting decision, those numbers provide as good a guideline as anything.

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It’s All in the Mix

You want to protect yourself against a bear market in stocks? If you have a diversified portfolio that includes bonds and money-market securities (“cash”), you will earn less over time, but you also won’t lose as much in a market decline. Here are average annual returns and average down-market losses for four portfolios for the period 1926-96. Also shown: losses in the two-year bear market of 1973-74.

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Avg. Avg. Portfolio annual down-market ‘73-74 mix return loss loss 100% stocks 10.7% -12% -37% 80% stocks 20% bonds 9.9 -10 -30 60% stocks 40% bonds 8.9 -8 -22 40% stocks 40% bonds 20% cash 7.6 -5 -19

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Stocks: S&P; 500 index; bonds: long-term Treasuries; cash: 3-month T-bills

Source: Ibbotson Associates