After a wild ride, time for investors to rethink
For all the anguish that many investors suffered during last month’s manic stock market swings, we may look back on the experience as a gift.
The damage to your portfolio overall probably has been modest. And things have calmed down enough this month that you now can consider changes to your investment mix away from the unhelpful pressure of a panic environment.
Maybe you don’t need to change anything. But if there ever was a year to do a midpoint review of your assets, this is it.
Here’s why: After the relatively blissful 13-month stock rally that ended in April, investors got the proverbial wake-up call in May and early June.
Put aside, for a moment, the idea that markets’ sudden wild volatility may largely have been the work of day traders or their high-speed computers. Maybe it was. But there were fundamental reasons for the upheaval.
The frightening turmoil in Europe’s financial system has raised the specter of another round of the global credit crisis. In the U.S., faith in a sustainable economic recovery was shaken by weakness in key indicators — most notably the dismal pace of private-sector hiring last month.
There have been other market depressants at work, too, including the horrific Gulf of Mexico oil spill.
Nick Sargen, who oversees $30 billion in assets as chief investment officer at Fort Washington Investment Advisors in Cincinnati, said the turn of events unsurprisingly left investors more uncertain about what the economy will do in the second half of 2010. And that raises the risk that markets’ tumult was just a prelude.
When his clients have asked him lately whether the sell-off in stocks is a normal “correction” or the start of a new bear market, “I tell them we’re not sure,” Sargen said. “It’s not the sexiest answer, but it’s the honest answer.”
Still, compared with the markets’ freefall of late 2008 and early 2009, this spring has been the equivalent of a mild case of indigestion.
The Standard & Poor’s 500 index, which inched up 0.1% Friday, is down 8.2% from its 2010 high set April 23. At its recent low reached June 7, the index was down 13.7% from the peak — still well within the limits of a classic temporary pullback, or correction, within a bull market.
And year to date the S&P is up 0.2%.
The broader market is a mixed bag. Shares of smaller companies overall are holding on to bigger gains than blue chips this year. Foreign stocks generally are in the red, in part because of the dollar’s strength against other currencies.
The average U.S. small-stock mutual fund is up about 6.4% year to date, according to Reuters/Lipper data. The average foreign stock fund is down about 4.6%.
As for bonds — they’ve been the portfolio buffer that many investors expected them to be. Counting interest earned and changes in principal value, year-to-date returns on most bond mutual funds are between 2% and 4.5%.
The markets’ divergences this year show that investors haven’t been looking to bail out of nearly all assets the way they did during the crash period of September 2008 to March 2009.
“We see a market that is becoming increasingly opportunistic,” said Quincy Krosby, chief market strategist at Prudential Financial in Newark, N.J.
That indicates that many investors still are engaged and looking for ideas rather than simply hunkering down. If you’ve got a well-diversified portfolio, this environment boosts the odds that you’ll own some winners.
That doesn’t impress some Wall Street bears who believe the economic recovery is fizzling, which they say will cause corporate earnings to crumble and lead to another deep dive in share prices.
Market tops tend to be drawn-out affairs as hope keeps luring investors back after sell-offs, said Steven Hochberg, chief market analyst at Elliott Wave International in Gainesville, Ga. It takes time “for people to connect the dots” about economic reality, he said.
But if you’re still willing to invest for the possibility that the recovery isn’t over — i.e., you don’t want to run for the hills — the best strategy now is to focus on whether your portfolio truly matches your risk tolerance.
Here are three points to consider as part of a midyear review:
--- Are you comfortable with your asset mix? This is another way of asking, “What’s your plan?” If you don’t have one, this is a good time to make one.
The most important investing decision is to set basic asset allocation percentages for stocks, bonds and cash, notes Christine Benz, personal finance strategist at Morningstar Inc. in Chicago. The idea isn’t to carve those target percentages in stone, but to stick with them until your risk tolerance changes.
If at the start of this year your target was to be, say, 50% in stocks, you still may be at about that level given the markets’ performance. If recent volatility makes you want to cut your stock weighting further in favor of bonds or cash, keep in mind that you could be sacrificing significant returns if economic growth continues this year.
What’s more, “With interest rates so low you have to ask, where’s the opportunity in bonds?” Benz says.
--- What are your investment options? Practically speaking, many investors are limited to what’s offered in their 401(k) retirement plan, because that’s where they do all of their saving (and for good reason, given the tax benefits and employer contributions).
But research shows that 401(k) investors often never review their plan options after settling on their initial choices, says David Wray, head of the Profit Sharing/401(k) Council of America, an advocacy group.
If you haven’t looked at all of your investment choices, you may be missing out on opportunities to further diversify your portfolio and potentially lower your risk level.
Outside of a 401(k), of course, your investment possibilities are unlimited. One option still missing from many portfolios: mutual funds that own bonds of emerging-market countries and companies. The bonds generally pay much higher interest rates than what’s available on developed-world debt, and yet the credit quality of many emerging-market countries and companies has been improving — unlike what has been happening with debt of developed European countries, for example.
--- If the worst happens, or something close to it, how would you fare? If markets were to plunge because of a new recession or another phase of the credit crisis, how much would you be willing to lose before selling some chunk of your stock holdings?
It’s better to think about that now than face the decision unprepared later.
If your goal would be to ride out any big sell-off, your ability to stay put may hinge on how much of a cash buffer you have. Morningstar’s Benz suggests that retiree investors should hold at least two years of living expenses in cash accounts to protect themselves. Working investors should build up a cash fund to cover at least six months of expenses, she says.
Cash pays nearly nothing these days, but the more you have the more likely you’ll be able to hang on to your long-term assets if May’s market volatility was just a prelude to something worse.
