Investors should face dilemma with logic

By Adam Shell
USA Today

NEW YORK — Owning stocks these days is about as fun as getting worked over by a pro wrestler.

With losses piling up and investors' threshold for pain nearing a breaking point, people with money tied up in the stock market are all asking the same question: What should I do?

While there's no easy answer, there are two schools of thought on how long-term investors should proceed:

• Optimists say now is a great time to snap up stocks at cheaper prices. "Periods of great uncertainty offer great investment opportunities," says Byron Wien, strategist at Morgan Stanley.

• Pessimists say stocks could get even cheaper and stay down or trade sideways for years. It's not too late, they say, to lighten up on stocks and add bonds, cash, real estate and other alternative investments to your asset mix.

The case for diversification makes sense if you consider the never-ending torture session that followed prior speculative bubbles. It took the Dow Jones industrial average 25 years to regain its peak after the 1929 crash, says Donald Straszheim of Straszheim Global Advisors. And Japan's Nikkei index is 73 percent below its 1989 peak.

"Let's hope," Straszheim says, "we don't have to wait that long on the Nasdaq." The Nasdaq is down more than 70 percent from its peak.

Felicia Wong, a 29-year-old Web page designer from New York, isn't waiting around.

"I'm shifting to tangible stuff like real estate," she says. "My husband and I are buying fixer-uppers and renting them."

The market faces a myriad of obstacles in the short term, ranging from accounting fraud to a crisis of confidence to fear of more terror attacks and a tepid profit recovery.

"You have to be foolish to partake in this market," says Lloyd Zuckerberg, 40, a New York-based real estate developer who got burned in the 1987 crash.

Whether you abandon stocks or ride out the storm is a tough, gut-wrenching call. What you ultimately decide should be based on rational analysis, not raw emotion.

Getting caught up in the short-term noise of accounting scandals and terror threats is a mistake.

"Too many investors are selling stocks because they feel bad," says Alan Skrainka, strategist at Edward Jones. "And it's a mistake to make decisions based on emotions."

Let's start with the basics of what you need to consider before selling. Your ultimate decision hinges on how old you are, how much pain you can endure and how much of your portfolio is riding on the market.

If you're 5, 10, 15 years away from retiring or don't plan on cashing in for a long time, now is not the time to stop funneling money into your 401(k) or Junior's college fund, says Russ Kinnel, head of mutual fund analysis at Morningstar.

"If you're buying a TV or a fund, you want it to be on sale, so the market's current weakness is clearly good news," he says.

At the other extreme, current market weakness does pose a dilemma for retirees. Hopefully, you have a large enough fixed-income component, such as bonds or money market funds, to cover expenses.

If not, you'll have to determine how to go about protecting principal and figuring out what stocks or funds to redeem, Kinnel says.

The case for stocks

Bonds are on track to outperform stocks for the third-straight year. That's only happened two other times: 1929-32 and 1939-41. And in both cases, stocks posted superior returns in the following four years, says Tom Galvin, equity strategist at Credit Suisse First Boston. "The case for rebalancing toward stocks is compelling," he says.

Some pros say stocks could fall further. Many of the sentiment, or so-called fear gauges, used by market pros have failed to return to the extreme levels of despair reached in the aftermath of Sept. 11. That's a sign that many investors have yet to throw in the towel, a contrarian signal pointing to more pain ahead, says Todd Salamone of Schaeffer's Investment Research.

"Wall Street keeps saying, 'Don't worry. Think long term, everything will be OK,' " says Gary Kaltbaum, host of syndicated radio show "Investors' Edge." "But how do you tell that to people who owned WorldCom, which is now a 10-cent stock?"

First, figure out your risk tolerance

There's a simple exercise to determine your risk tolerance, patterned on an old saying, "Sell to the sleeping point," says Jeremy Siegel, finance professor at the University of Pennsylvania's Wharton School of Business.

In short, ask yourself if you could handle a further drop of, say, 10 percent or 20 percent.

If the answer is no, than you need to lighten up on stocks. Siegel, however, believes now is the wrong time to give up on stocks.

How much you have riding on stocks, and where, also is a key factor.

"It's not a question of staying in or out, it's a question of what you are in," says Tony Ogorek of Ogorek Wealth Management.

If your portfolio is 100 percent stocks or heavily weighted toward tech stocks, you're probably putting too much at risk and should reduce your exposure, he says. However, if you have a nice mix of stocks, bonds, cash and own a home that's rising in value, you'll be able to ride out the market's final nosedive just fine.

Other tips offered up by financial planners include:

• Calculate the opportunity costs.

If you're reluctant to sell beaten-down techs, you might be missing out on gains in other investments with more potential, says Dee Lee of Harvard Financial Educators.

• Consider tax-loss selling.

Even if your portfolio isn't a complete mess, don't hesitate to take some tax losses, says financial planner Don Lutomski in Birmingham, Ala. "No one likes to sell stocks when they're down, but we take losses to offset tax gains," he says.

You can use your capital losses to offset an unlimited amount of capital gains. If you have more losses than gains, you can deduct $3,000 of your losses from your income this year. You can carry forward additional losses to next year. If you like, you can buy the same stocks or funds back 31 days after selling.

• Avoid "timing" the market.

Jumping in and out of the market — often referred to as timing — isn't as easy as it sounds. Investors often make the mistake of buying near market tops and selling near bottoms, a flawed strategy that reduces long-term returns.

The average stock-fund investor had an annualized total return of only 5.3 percent from January 1984 through December 2000

— one of the best 17 years in stock market history, according to the research firm Dalbar. The average stock fund gained 13.3 percent in the same period. Dalbar blames that underperformance on investors "shifting money around at inopportune times."

"While it may seem illogical to buy more when the market is going down and the economy is weak, that's the principle behind a successful investment strategy," says David Testa, chief investment officer at the mutual fund giant T. Rowe Price.