In tough times, don't give up on stocks

By Walter Updegrave, senior editor


(Money Magazine) -- Question: We have nearly all our savings in stock funds and are very concerned that the stock market is headed for another large downturn with an oil crisis on the horizon. Would you recommend that we switch to bond funds? -- Jessica Sprague, Gig Harbor, Washington

Answer: I have no idea whether we're heading for an oil crisis as you suggest. But if you're looking for a reason to be wary about investing in stocks, why pin it only on oil? There are always plenty of potential culprits to obsess over that might drag stock prices down.

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Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005)

Over the past two years, for example, all anyone looking for an excuse to stay out of the stock market had to do was point to the wobbly economy. I mean, back in the dark days of 2008 when Lehman Brothers declared bankruptcy and it appeared the financial system and our economy were on the verge of meltdown, barely a day went by when I didn't receive emails telling me that only idiots or gluttons for punishment would invest in stocks.

And even today, after Fed chairman Bernanke forecasted a "moderate economic recovery in coming quarters" in Congressional testimony, there are still plenty of reasons to be skittish of stocks: big budget deficits here and abroad, the specter of rising inflation in the years ahead, more potential fallout from the devastated housing market.

Hell, the mere fact that the stock market has had a run-up of more than 70% from its March 2009 low is enough to have many people believing that we're in for another big setback any day now.

But moving in and out of stocks based on what your gut (or even your head) says the market might do is no way to build wealth over the long-term. It's just too difficult to make the right call consistently.

Indeed, a recent paper by researchers at Tel Aviv University that examined flows between stock and bond mutual funds found that investors tend to get it wrong, or, as they put it, "we find a negative relation between flows and subsequent market returns."

I'm not surprised. In the 10th anniversary edition of his book "Common Sense on Mutual Funds," Vanguard founder John Bogle lays out a neat little chart in the first chapter showing how between 1970 and 2008 investors were more likely to pile into stock funds just as returns were about to sour and more likely to bail out when returns were about to soar.

I'd also note that as the stock market was mounting its robust recovery over the past year or so, Morningstar data shows that investors threw much more money at bond funds than stock funds.

So, getting back to your question, no, I don't recommend that you switch from stock funds to bond funds -- at least not entirely. Instead, I recommend that you shed this "switching" mentality and adopt an "allocation" mindset. Or, to put it another way, instead of moving back and forth between stocks and bonds, I suggest that you create a portfolio that includes both stock and bond funds, and largely stick to it regardless of what the market is doing (or what you think it might or might not do).

Since you've already got all your savings in stock funds, following my advice will mean moving some of your stash to bond funds. How much?

That depends on a variety of factors, but mostly comes down to how long you think you'll keep your money invested and how much risk you're comfortable taking. The longer your investing horizon, the more you'll likely want to keep in stock funds. And the more antsy you get when you see the value of your savings decline, the more you'll want to invest in bond funds.

For guidelines on how you might want to divvy up your savings, you can go to our Asset Allocator tool. To see how a particular stocks-bonds mix might perform over time, you can check out this Morningstar tool that goes by the same name.

The object of this approach isn't to get the highest possible return. In fact, it pretty much assures you won't, as you'll never have all your money in the asset class that performs the best.

Nor will it completely insulate you from losses, as you'll always have at least some money in stocks when they hit the wall, as they periodically will do.

So what's the point then? Well, the idea is that over the long run you'll be able to earn a reasonable return that's commensurate with whatever level of risk, or volatility, you're willing to take.

And, just as important, you'll be able to deal with the uncertainty of the financial markets in a rational, disciplined and systematic way, as opposed to trying to guess what to do every time you think an oil crisis or some other calamity is brewing. To top of page

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