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Don’t Panic!
Investors need to
stay the course to ride the bearish markets
by
Al Karr
for
Virginia Business
March 2003
These
days, many investors race for the Alka-Seltzer when
they see monthly statements of their personal holdings.
Dow Jones Industrials, the S & P 500 and the Nasdaq
over-the-counter index have all sustained huge losses
— 32, 46 and 75 percent, respectively — since
their bull market peaks in early 2000. Desperate, investors
are flocking to financial planners to find out what
they should do. So, are they being told that now is
the time for a sweeping new strategy? Not at all. Instead,
many financial advisers in Virginia and elsewhere are
urging investors to stay the course — to follow
the same kind of asset allocations they were told to
follow in those days of market exuberance a few years
ago. They’re advised to climb aboard the asset-allocation
bandwagon if they’re not aboard already. Plus,
they need to make periodic adjustments to their holdings
in stocks, bonds, real estate or cash. Doing so helps
maintain their own particular asset-allocation formula
when any one of those investment segments upset the
balance by growing dramatically or shrinking significantly.
For
many investors, this means taking some profits in stocks
when stocks begin to play too large a role in one’s
portfolio because they’ve risen in price. It also
means buying more stocks when their prices have dropped
so far that stocks now claim too small a percentage
of the portfolio. “Nothing that’s going on
has caused us to change our investment philosophy or
strategy, so our advice has not changed over the past
10 years,” says Ric Edelman, founder and chairman
of Edelman Financial Services in Fairfax. “The
proper strategy is really two steps — first, to
maintain a highly diversified portfolio, and second,
to hold the portfolio for a long period of time.”
Diversification
means a range of U.S. and foreign stocks, between large-,
mid- and small-cap, and between growth and value stocks.
It also includes a mix of bonds, government securities,
real estate, natural resources such as oil, gas or precious
metals, commodities and as much as 12 months spending
money in cash, he says. While most individual investors
lack the discipline to do so, they “must hold that
portfolio through thick and thin,” with occasional
rebalancing to keep investment classes from getting
out of whack. And they should shun market timing, reflecting
what the investor “thinks has happened or is going
to happen,” Edelman insists.
If,
as an investor, you maintain a diversified portfolio,
you probably have discovered that you didn’t suffer
substantially in the bear market of the past three years.
Thus, you’re still on track, meeting your financial
goals such as buying a house, getting kids through college
and being able to retire in financial comfort. Stocks
are an important component of this buy-and-hold approach
because they have historically outperformed other types
of investments. Over the long haul, “the question
is not whether you will make money in stocks —
the question is how much you will make,” Edelman
says.
Once
one makes an allocation, he or she should stick with
it. If, for example, an investor puts 60 percent of
his money into bonds and 30 percent into stocks, the
scheme should be changed only for special situations.
These include nearing retirement, a sharp drop in income,
or a substantial spending need like buying a house or
sending children to college. “Many investors and
advisers got away from the concept of allocation”
in the exuberant days of soaring stock prices that ended
three years ago, says Kenneth Coan, whose Sevila-Coan
Financial Group works in the Tysons Corner branch office
of Prudential Securities in Vienna.
Now,
if one’s portfolio is heavily out of balance, moving
into a better allocation requires some strategies aimed
at reducing the tax impact from selling investments
in order to put the money elsewhere, says Patricia Houlihan,
a certified financial planner and principal of the Houlihan
Financial Resource Group in Fairfax. This could include
letting gains run, taking tax losses and straddling
tax years with carry forwards on stock losses.
But
with a proper allocation in force, advisers like Coan
recommend an approach that most investors find difficult
to follow: sell winners and plow money into losers.
Historically, stocks, bonds and other asset classes
rise into and fall out of favor regularly. Rebalancing
one’s portfolio performs that function well, and
right now that often means buying stocks. Buying mutual
fund shares or having an experienced manager make the
investment decisions is the best approach, Edelman and
others say, because it provides good diversification
and lets professional money managers decide what stocks
to buy or sell.
Rebalancing
doesn’t mean selling stocks now, which are near
a market bottom after the three-year plunge, advisers
say. Doing so would mean that “you screwed up because
you were too greedy (in the late 1990s), and now you’ll
screw up by being too fearful,” says one Merrill
Lynch, Pierce, Fenner & Smith financial adviser.
While eschewing market timing in general, some advisers
are nevertheless saying that with the economy weak and
war with Iraq looming, it’s best to hold off on
new purchases of stocks for a short period. And some
advisers warn that the outlook is for a tough investing
market for some time to come.
But
many advisers are turning bullish about the longer-term
outlook. They cite sizable outflows of money invested
in mutual funds last July and October. “Our firm
is unabashedly bullish. We think it’s one of the
safest times in history to own stocks,” says Stephan
Cassaday, president and managing executive of Cassaday
& Co., an advising firm in McLean.
Bonds
are falling out of favor with many of these contrarian-minded
advisers, because bonds are getting so much attention
from investors who have been disillusioned by the big
stock-market plunge. When a bond fund became the largest
mutual fund last summer, “that was the death knell
for bond funds,” says Carl Zangardi, vice president
of Williamsburg-based Intech, which advises institutional
funds. He says the next big move in interest rates will
be up, which means that bond prices will decline. It’s
okay to buy bonds with short, 12- to 18-month maturities,
but stay away from long-term bonds, says Prudential
Securities’ Coan. Houlihan suggests “laddering”
purchases of bonds, those with maturities of six, 12,
18, 24 and 60 months, so that as they mature, the money
that rolls in can be put into higher-interest bonds
with some regularity. Other advisers like Cassaday prefer
mainly “junk” bonds, with their high interest
rates, because they’ve lost favor with many investors
and are thus prime candidates for a rebound.
Rebalancing
would trim investments in other kinds of assets that
have made recent gains as well. Greg Popera, a private-wealth
adviser for Merrill Lynch in Vienna, told clients to
boost their investments in REITs in the late 1990s,
when those real-estate trusts were dropping in value.
But since they’ve been gaining about 10 percent
a year over the past two years, if an investor has a
real-estate investment target of 5 percent of his portfolio
and his REITs investment exceeds that, he should scale
back to the target, Popera says. In other words, the
rush to buy real estate as an investment haven is now
happening too late in his view. Indeed, most people
make the mistake of waiting too long to jump into an
investment asset that has been doing well. They should
take the plunge before it starts doing well.
And
what do the advisers say to an individual investor who
has $1 million to invest, much of it already invested
somewhere? They all start with a caveat: they tailor
each portfolio to the individual, depending on income,
net worth, family status, investment goals, any major
spending plans, when they plan to retire, what rate
of return is sought in the meantime and afterward and
one’s risk tolerance. There is no standard set
of allocations.
Even
so, Cassaday & Co. says its most popular model is
a portfolio with a “moderate growth” objective.
The investor would have 52 percent of his or her money
in U.S. stocks and 22.5 percent in foreign stocks —
up from 45 percent and 20 percent in January 2002. Meanwhile,
in the same time frame, funds invested in bonds, hard
assets (raw materials such as oil, gas and precious
metals and real estate investment trusts), and cash
have declined to 15 percent, 8 percent and 2.5 percent,
down from 20 percent, 12 percent and 3 percent, respectively.
Within those asset categories, Cassaday has been putting
more money into small-cap stocks than large-cap, more
into growth stocks than value stocks and more into high-yield
and short-term bonds, moving out of quality and long-term
bonds.
With investors more risk averse than they were as the
20th century was winding down, the firm is seeing a
sharp rise in enthusiasm for this portfolio. Three years
ago, “we would recommend the moderate approach
and we couldn’t get anybody to use it,” because
they were all eager to just buy growth stocks, says
Cassaday.
Prudential’s
Coan sees a “moderate” allocation of 65 percent
stocks and 35 percent fixed-income investments as appropriate
for someone age 40 with annual income of $90,000, net
worth of $800,000 and $700,000 to invest. Allocations
of 50-50 and 40-60, stocks-to-bonds, would be more appropriate
for persons age 52 with income of $158,000, net worth
of $1.3 million and $1 million to invest, or age 60
with $200,000 annual income, $1.6 million net worth
and $1.3 million to invest. Ric Edelman is more conservative,
regarding allocations of 30 to 50 percent in stocks
and 50 to 70 percent in bonds as more appropriate for
most people.
A
big consideration, along with the amount of time before
the money is needed, say for retirement, and the rate
of return that would be necessary to achieve the goal
in the meantime, is the investor’s tolerance for
risk. By and large, that tolerance has diminished greatly.
“A lot of people have become more conservative
in the past three years,” says Kim Cox, a certified
financial planner with West Financial Services Inc.
in McLean. “Somebody who thought they could tolerate
risk, now that they understand what risk entails, their
tolerance level has declined,” she says. So if
an investor has been 70 percent invested in stocks and
now can’t stand that level of risk, “we would
slowly, over time, work that down,” by dollar-cost
averaging out of the market — selling a set number
of shares every quarter, Cox says.
But
as one nears retirement, most advisers say it’s
best to scale back one’s investment in stocks —
to zero in Edelman’s view, to low percentages in
the view of others — because the investor may need
the money at a time when the market has declined sharply,
and there isn’t time to wait for a new bull market.
Still, investors shouldn’t be avoiding stock purchases,
warns Segal’s Shanklin, because “people are
living longer after retirement” than ever before,
and some holdings in stocks are necessary to keep pace
with inflation.
Editor’s
note:
The writer retired after spending 40 years as a reporter
and editor with The Wall Street Journal.
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