Hang in there and diversify:
How to hang in there 2002-07-26
A four-point plan for surviving the market's slings and arrows
by Ted Allrich, founder, The Online Investor
"What should I do?"
I hear this question wherever I go these days. Everyone from high-net-worth investors to people with a few thousand dollars in a 401(K) account are wondering how to respond to the current whipsaw market. Here's my four-point plan for surviving in a brutal time.
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First, make sure you have at least a five-year horizon for your portfolio. If you need your money within a year, you had better start selling now and conserving your capital. While it looks like we are near a bottom, another exogenous shock will definitely take stocks lower, all of them. But if you have time on your side, don't sell anything—unless it's to upgrade to better stocks.
That's the second part of my advice. Use this opportunity to buy the best stocks. Of course it's painful to sell stocks that are down 50 percent or more. But if they're secondary or tertiary stocks, they won't lead the rally back. The best stocks in each industry will be the first to recovery substantially. So be brutal with your portfolio and get rid of the weaker stocks. Then buy some great stocks at great prices. Names to consider? Look at Johnson and Johnson (JNJ), AIG (AIG), and Intel (INTC). (These are not "buy" recommendations; they're ideas for further investigation.)
Third, understand that this is an emotional time for the market; economics and earnings are not the driving factors. That means good economic or earnings news will not necessarily mean upward price movement for stocks. With fear dominating the market, any good news may seem like an opportunity to sell rather than one to buy. Stocks have not been able to sustain any rally for more than a day or two. The feeling is that tomorrow, conditions will deteriorate rather than improve. That sentiment has to reverse before we see a sustained rally. Since we're talking about emotions—not objective conditions—the situation could linger for a while.
Finally, stay diversified. Pick the best stocks in at least ten different industries that are at most minimally correlated. This market has drummed home the absolute need to diversify. That includes some bonds or bond surrogates like preferred stocks or dividend-paying stocks.
But be realistic about alternatives. Of course, you can put your money in a CD that will earn you 3 percent, but if you've lost a lot of money, you may not live long enough to recover your losses—much less actually make money on your principal.
And real estate in many parts of the country is at the bubble stage. You'll know if you're living in one of them if you've seen housing prices continue to soar despite the weak economy. Real estate may keep going up, but the odds are against it. Gold is another hot sector, but it relies on inflation to create wealth. There is no talk of inflation, much less any sign of it in the economy. Furthermore, gold doesn't throw off any income.
Historically, the stock market has offered the best risk-adjusted returns. Right now, everything is on sale. If you have sufficient courage—and the ability to sleep at night in a rough market—you will probably be rewarded for it.
So what do you do right now? Upgrade your portfolio. Hold fewer but better stocks. Diversify. And hang in there.
Ted Allrich is a registered investment advisor and the founder of The Online Investor.
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