Sell stocks or stay put
The value of your portfolio is dwindling by the day. So what should you do about it?
NEW YORK (Money) -- Question: I've been sticking with my investments in the hopes that the market will recover, but I'm tired of seeing the value of my portfolio continue to drop. Should I just sell everything, put the proceeds into money-market funds and bonds and wait until we see an upturn before getting back in the market? Or should I hang in there with my present portfolio of stocks and mutual funds? Eric Rosenberg, Little River, South Carolina
Answer: You've asked two questions that I'm sure nearly all investors are grappling with today to one degree or another.
Given the market's dismal performance, should you sell your stock holdings, hunker down in safer investments and jump back into equities after stock prices have rebounded?
Or should you just ride out these tough times with the portfolio of stocks and funds you already have?
It may seem that by answering the first question, I would also automatically be answering the second. But in fact, even though these two questions are related, they require separate answers.
So let me start with the first: The answer is no.
On the face of it selling now, sitting safely on the sidelines and then reinvesting once stock prices have recovered seems like the obvious choice. After all, why own stocks when the market is struggling if you can simply wait until the turnaround arrives and buy in then?
Not so fast. The problem is that it's hard to tell when stock prices have bottomed out and are turning around for the longer term.
Let's take a quick example. In early October, 2007, the Dow Jones Industrial Average hit a peak close of 14,164.53. Then the you-know-what hit the you-know-what. The Dow began falling, eventually dropping 17% by the beginning of March, 2008.
But then the market began to dramatically improve. By early April, 2008, the Dow had rebounded almost 5%. And by early May it was up 11% from where it had been just two months earlier.
If you had pulled out of the market in late 2007 or early 2008, you might very well have seen the rally in the spring of 2008 -- a double-digit gain in less than two months -- as a signal to get back in. It looked like stocks were back.
But with the benefit of 20/20 hindsight, we now know that this rebound fizzled, and stocks dropped again. The Dow plummeted 42% between May and late November, 2008.
Ah, but the Dow then rebounded by 20% from November, 2008 to early January, 2009. Sign of the big turnaround? Apparently not. By the end of January, the Dow had slumped 11%.
My point is to show that people are being unrealistic when they talk about moving out of stocks to avoid losses with the aim of getting back in to reap returns after they've turned around. It's easy to distinguish promising-but-aborted rallies from sustainable long-term turnarounds when you're looking at past performance. It's quite a different matter when you're living through the ups and downs in real time.
The rub is that you have no sure way of knowing in advance whether a rebound is going to continue or give way to another downdraft. You can try waiting it out. But how long do you wait? A week? Months? Until stock prices have increased by a certain amount, say, 20%?
But remember, if you set the bar too low, you run the risk of getting in too early and getting hit for a loss again. The longer you wait, on the other hand, the more return you give up before you get back in.
Keep in mind too that if you jump back in only to get burned by another setback, you may very well become gun shy about re-entering the market again, which may mean more delay about getting back in and more lost return in the future.
Rather than play this sort of pointless guessing game, I believe you're better off coming up with an allocation of stocks, bonds and cash that makes sense given your tolerance for risk and your investing time horizon. Then, aside from periodic rebalancing, selling for tax losses and routine maintenance like weeding out investment that backfired or that you shouldn't have bought in the first place, you largely leave your portfolio alone.
You want to limit your stock holdings if you're investing for short-term goals or you need extra security for your portfolio, as is the case for most retirees. If you're investing for longer term goals, you have more time to recover from short-term setbacks, so you can afford to allocate more of your money to stocks.
This sort of diversification won't immunize you from losses. But it will give you a good shot at maximizing your returns. And it's better than engaging in the futile exercise of trying to figure out when to exit and then get back into the market.
Which brings me to your second question: Should you just hang in with your present portfolio of stocks and mutual funds?
The fact is I don't know whether you should stick with your present portfolio because you have given me no clue as to what your portfolio looks like or why you're investing this money.
If you're 30 years old, planning to retire in 30 or so years and have 80% or more of your money in a well-diversified group of stocks with the rest in a broad mix of bonds, then I'd probably say you have what seems like a decent mix of assets for someone willing to take reasonable risks for long-term capital growth.
If, on the other hand, you're in your 60s and have the same portfolio, I'd probably tell you that hanging onto your current portfolio would be a mistake. It's likely far too risky for your situation.
In short, the issue of whether you should stick with your current portfolio really comes down to whether your portfolio is appropriate for your situation. You can get a better sense of that by going to our Asset Allocator, reading our Money 101 lesson on Asset Allocation or consulting an adviser.
So to sum up, yes, I think you should resist the impulse to switch out of stocks and into bonds and cash, however tempting doing so may be in today's scary market. But before you simply stay the course with your current portfolio, make sure you've set the right course in the first place.