To Limit a Bear’s Bite, Focus on Portfolio Mix

If you could time Wall Street’s swings perfectly, you’d be out of stocks when bear markets began and you’d go back when the bull returned. But no one has yet demonstrated the ability to get that timing right consistently.

For most investors, the best way to protect against being ravaged by a bear market is to follow the simplest rule of all: Keep your portfolio well diversified. That means owning a mix of large-company stocks and smaller stocks, U.S. and foreign issues, fixed-income investments such as bonds, money market funds and bank savings certificates, and “hard” assets such as real estate and commodities.

The problem for many investors in the bear decline of 2000 to 2002 was that all they owned were blue-chip U.S. stocks and technology issues, the two sectors that led the bull market of the late 1990s. Not surprisingly, those two sectors had the furthest to fall when the bull ended.

Investors who went into the last bear market with foreign stocks, small-company issues, bonds, real estate and commodities in their portfolios would have found that those sectors generally held up better than blue chips and tech shares in the decline. That’s the goal: You want some elements of your portfolio to zig when others are zagging.

“Investing is never an all-or-nothing proposition,” said James Stack, editor of the InvestTech investment newsletter in Whitefish, Mont. That seems basic enough, but it’s amazing how many people ignore the basics and allow their portfolios to be dominated by one type of investment, he said.

Perhaps the worst sin of all: holding an excessive percentage of the assets in your 401(k) retirement plan in your employer’s stock. Many financial advisors say your company’s shares should never exceed 20% of your 401(k) assets.

If the last bear market caused you to turn more conservative and better-diversified, and you have a major portion of your total portfolio in fixed-income accounts, you may have little to fear from a drop in stock prices -- provided you won’t need the money for at least five years. Indeed, your portfolio mix might give you the courage to shift more into equities if prices continue to fall in the next few months.

“I think it’s time to pay attention not to selling but to looking for some of the stocks you’ve been hoping to buy,” said Charles Carlson, a portfolio manager at Horizon Investment Services in Hammond, Ind. In the case of a 401(k) account, that might mean reviewing all of your available investment options and considering which may be underrepresented in your mix.

Even investors who have the bulk of their savings in stocks may not face the same risk they did in 2000. Because blue-chip shares are the bedrock of many people’s portfolios, and because those issues have been financial markets’ great underachievers in this decade, their downside could be limited, some market pros say. This time, it could be smaller stocks and foreign issues that lead a new bear market, Stack said.

But bear markets are inherently unpredictable. You can’t know when they’ll begin, how far they’ll go or which stock groups will lead the decline. That bolsters the case for keeping your assets spread across the investment spectrum.