Posted on: Sunday, May 27, 2001
Advice on recovering from portfolio shock
• Pension returns weaken as stocks slide
USA Today
If you're not feeling well, you've probably been looking at your mutual fund portfolio. Returns from the past 12 months would make most anyone sick.
But what should you do? It depends on just how badly your portfolio has fared, and whether it's geared toward your investment goals.
Here's a look at three types of ailing portfolios, and how to get them back up and dancing.
Big losses • Portfolio symptoms: Gaping losses far beyond the Standard & Poor's 500-stock index; acute destruction of principal. • Investor symptoms: Panic attacks, sleeplessness, heart palpitations, clammy skin, tremors. • Diagnosis: Wildly inappropriate portfolio for your risk tolerance and investment goals.
So how bad is your portfolio? You have a fistful of aggressive growth funds and sector funds — mainly technology — and you need to use the money in the next three to five years.
Your first step: Make sure that you really have an emergency situation and not just buyers' remorse, said Malcolm Makin, a financial planner in Westerly, R.I. For example, you may have believed strongly in leading high-technology companies a year ago. Now your holdings are down 50 percent or more.
"Now that everything is in the trash can, people think they have failed," he said. In fact, in time their portfolio will probably recover. Your best bet: Take a deep breath, hang on, and wait for your stocks to come back.
But if you were investing in technology stocks and you'll need income in the next few years, then your portfolio needs major surgery. You need to cut out many of your most aggressive holdings and transplant conservative stock funds, bonds and cash into your portfolio.
Selling all your stocks at once — even after the recent rally in tech stocks — could be a mistake, however. "I wouldn't bail out of stocks that are good companies now, while the Fed is still lowering rates," Makin said. Lower interest rates often push stock prices back up.
And you can only deduct $3,000 of your losses from your income each year. So unless you have big capital gains bills this year, your tax benefit will be small if you sell all your losers at once.
If you need money to pay bills, then sell just enough cash to get you by for a few months. Sell your holdings gradually as they recover.
As you sell, move the proceeds to more conservative stock funds, which will help reduce your portfolio's overall volatility.
For example, consider a portfolio composed entirely of large-company growth funds. These funds, like American Century Ultra or Janus Twenty, look for red-hot earnings growth. The worst three-month period in the past 10 years would have lost 24.3 percent.
Value funds look for stocks that have already been beaten up by Wall Street, so they tend to be less volatile. Worst period: A 13.6 percent loss.
But if you really need income and stability, you should add cash and bonds to the mix. An income-oriented portfolio should have half or more of its assets in bonds and money market securities. You'll get lower long-term returns, but you'll reduce your risk of big losses, too.
Moderate losses • Portfolio symptons: Average losses, long-term reduction in returns. • Investor symptoms: Feelings of frustration, headaches, frayed nerves. • Diagnosis: Typical but painful market burn.
Everything was going so well just a few years ago. After triple-digit gains in 1997, 1998 and 1999, you thought you were on course to retire early.
Then came 2000. And 2001. And suddenly, those dreams of sleeping on a mattress full of freshly pressed $20 bills seem a bit naive.
If you own an average stock fund, even typical losses are depressing. Consider:
The Standard & Poor's 500-stock index is down 11.6 percent the past 12 months, assuming dividends were reinvested. The average stock mutual fund is down 6.7 percent.
The average large-company growth fund, which looks for stocks of rapidly growing companies, has fallen 23 percent.
The average technology fund has plunged 43.8 percent.
Even if you've done everything right — set goals, diversified your portfolio, and invested cautiously — you still might be shocked by your losses.
For example, suppose you set up your portfolio 12 months ago. You decided you'd be 15 percent in money market funds, 15 percent in U.S. government securities funds and 70 percent in large-company growth funds.
You made 10.1 percent on your government securities fund and 5.9 percent on your money market fund. Unfortunately, your large-company growth fund swooned 27.8 percent. All told, your portfolio is down 17.1 percent.
Aside from your losses, you have another problem: Your portfolio is out of balance. You now have only 61 percent in large-company growth funds, 19 percent in money funds and 20 percent in government securities.
So it would make sense to rebalance: Move enough money from your other funds to bring your stock fund back up to 70 percent of the portfolio.
Regular rebalancing can cut down your portfolio's overall volatility. But taxes and transaction costs could make it a futile effort.
Treatment: Portfolio rebalancing and diversification, infusion of new cash when possible. Post-operative tax treatment recommended.
"Normally, we only consider rebalancing once a year, or if the portfolio is 10 percentage points out of whack," said Alexandra Armstrong, a financial planner based in Washington.
Rebalancing now would move money from defensive securities, such as bonds and money funds, into stocks. If you're a long-term investor, that's what you want to do. Normally, bonds and money funds earn far less over time than stocks do.
"The past 12 months have shown that it's OK to have bonds in your portfolio," Armstrong said. "But sooner or later, the pendulum will swing back."
Small losses, below-average gains • Portfolio symptoms: Mild losses to below-average gains. • Investor symptoms: Depression, discouragement, general unease. • Diagnosis: Take up a hobby; you're doing well.
Your portfolio is down less than 10 percent the past 12 months, because you own a diversified portfolio and you've invested cautiously. Nevertheless, you feel mildly depressed — and discouraged. You're not as interested in investing as you used to be. And you feel uneasy about the market to come.
What's to be done? "Be grateful," said financial planner Mark Bass of Lubbock, Texas. That's not easy, but sometimes your best therapy in a decline is to put your troubles in some perspective.
In fact, one way to feel better is to see how badly everyone else did. If you're down just 10 percent or less, you're beating the Standard & Poor's 500-stock index the past 12 months. Some funds would spend thousands of dollars on ads to brag about that.
And some parts of the stock market did far worse than the S&P 500. The Nasdaq, for example, has plunged more than 40 percent the last year. And the average technology stock fund is down 44 percent.
Another way is to realize that, even with bad timing, you're better off in stocks for the long run than in bonds or money market mutual funds. A Charles Schwab study looked at four hypothetical investors from 1980 to 2000.
One invested $2,000 every year at the best possible time — that is, at the market's low each year. After 20 years, this investor had $387,120.
One invested $2,000 every year at the start of each year. This investor had $362,185 after 20 years.
One invested $2,000 at the worst possible time — the market's highest point. After 20 years, this investor had $321,569.
One simply put money into risk-free Treasury bills and had just $76,558 after 20 years, the worst returns of all.
Clearly, even an investor with rotten timing did better than one who avoided the stock market entirely. So even if your results this year didn't impress, you're likely to do well the next 20 years.
If you're still distressed, take another look at your entire portfolio. Investors often concentrate on their one losing investment, rather than on others that do well. "We try to get people to know that even if one piece is down 50 percent, other parts are up," Bass said.
What if you just can't shake the blues? Consider the tried-and-true remedies: long walks, good books and chocolate.
