Amid market upheaval, four questions investors should be asking
Time to turn off the autopilot.
For stock investors, it has been blissfully easy over the last six months to watch the market climb with just a few minor air pockets along the way.
Now, nerves are fraying over the outlook for oil prices and supplies, triggering fresh doubts about what had been an improving economic outlook.
Yet so far, stocks have remained amazingly resilient even as oil has surged 17% since Feb. 18, to $101.16 a barrel at week’s end.
This is the right moment to reconsider whether your portfolio matches your risk tolerance — while the damage to markets still is modest.
The Dow Jones industrial average, which inched up 59.79 points, or 0.5%, to 12,044.40 on Friday, is off just 2.8% from its 32-month high of 12,391.25 on Feb. 18. Broader market indexes are down between 3% and 4% from their highs.
Markets are supposed to do a good job of anticipating the future, but by definition they aren’t prepared for out-of-the-blue shocks.
This year, the escalating unrest in the Middle East and North Africa is the shock that hadn’t been on most people’s worry lists.
Whether it will be enough to derail the global economy is far from clear. But every Wall Street talking head has uttered the same warning in the last few weeks: At some price — $120 a barrel, $130, $150 or pick another number — all bets are off.
As John Maynard Keynes supposedly said, “When the facts change, I change my mind. What do you do?”
And what if calls for a “Jasmine Revolution” in China begin to stoke massive demonstrations there? It’s not a question of rooting against democracy but of weighing the risk of short-term economic upheaval in getting there.
It’s also conceivable that oil prices are topping out. So far, it isn’t a shortage of crude that’s the problem but rather the fear of a shortage developing at some point.
If the Middle East calms down, whatever that may mean, crude could stabilize or even decline from here, economic fears could dissipate and stocks could rebound in a hurry.
But it’s better to take time to think now about how you would react if the economy and markets worsen. If you need more motivation, imagine if you had gone through such an exercise in August 2008, before the crash. You might have saved yourself a lot of anguish.
Here are four questions to consider:
•How much can you afford to lose?
You can’t predict the future, but you can set parameters for action, depending on what markets bring.
Say your 401(k) account now is heavily in stocks. Would losing more than 10% from this point, on paper, be too much to bear psychologically? Then you need a plan for paring back if the market slides further.
The beauty of 401(k) accounts is that it’s easy to shift assets with a mouse click, and without triggering tax consequences.
But that also can encourage reckless trading. Keep in mind that a typical “correction” in a bull market — a normal sell-off as opposed to a crash — can shave 10% to 20% off share prices before buyers flock back. That’s what happened last spring when the Standard & Poor’s 500 index fell 16% from April 23 to July 2 as the U.S. economy slowed and Europe’s debt crisis flared.
If you exit the market completely and stocks quickly snap back, the risk is that you’ll miss much of the rebound.
The point of a portfolio review is to check the percentages of assets you now have in stocks, bonds, cash and other investments, and decide whether you’re comfortable with your mix. Note that stocks have soared 20% to 30% just since August.
It could be that your mix still is exactly what you want, and that there’s no need to change anything, even if you expect stocks to fall further in the short term.
•Have you sold any of your investments since March 2009?
Stocks, bonds and commodities all have generated strong returns over the two years since Wall Street hit its recession lows. U.S. stocks’ gains, in fact, have been among the largest in any two-year period in history, with the S&P 500 index up nearly 100%.
That has done a lot of repair work on portfolios that were devastated in the 2008 crash.
Remember the old line: “Nobody ever went broke taking a profit.”
True, many stocks remain well below their pre-2008 highs. But people often get mentally stuck on the idea that they won’t sell an investment until it gets back to even. You could wait forever. If your gut is telling you to take some money off the table, this may be a great time.
•Do you have some better investment possibilities than what’s in your portfolio now?
The best reason to sell something is to generate cash to use for a better idea.
Tax-free municipal bond yields surged from November through mid-January amid a panic over the budget woes of many states and municipalities. Those yields have come down a bit over the last two months, but they’re still relatively high compared with what taxable bonds pay. If you’re looking to lock in some decent income, high-quality munis are worth considering.
If you’re expecting stock markets worldwide to take a bigger hit in the next few months, it may just be worth raising cash to be ready to move in at lower prices. Make up your wish list now.
Many emerging markets already have lost more ground than U.S. stocks as their governments have tightened credit to battle rising inflation. Brazil is down nearly 9% since early November; India is down 13.5%.
Commodities also would get more interesting at lower levels, if you believe that global demand is likely to drive prices higher in the longer run.
Another use for investment proceeds if you have securities to sell outside of a retirement account: Pay down high-cost debt, such as credit card balances.
•Are you aware of all the diversification options within your 401(k) plan?
Spreading your money around different kinds of assets still is the best long-term investment strategy.
If you save primarily through a 401(k), that means you ought to review periodically what’s available in the plan and whether there are investment choices that you’ve overlooked or have been added since you last made your allocations.
