What do you do with that sinking feeling as you watch the Dow Jones industrial average tumble more than 500 points and hear market observers say they’ve never seen anything like this financial meltdown before?
“Don’t be a hero,” said Standard & Poor’s investment strategist Sam Stovall. “We’ve only had a baby bear (market) so far, with a drop of only 23 percent.
“There hasn’t been enough penitence to atone for the subprime disaster,” he said, referring to the lending to people who couldn’t afford mortgages, which touched off the housing plunge.
Even if this is simply an average bear market, the stock market should fall another 5 to 10 percent.
Still, that doesn’t mean Stovall thinks you should gather up what’s left of your investments and run for cover.
It means to pause, to look over your portfolio to make sure it’s appropriate for your needs, be careful about jumping too quickly into stocks that might look cheap, and then consider history — or the fact that that stocks drop about 30 percent in the average bear market, but then eventually recover. It’s not unusual for the market to climb more than 40 percent the year after a big decline.
Financial planners give similar advice. Ingrained with the lessons of history, they realize that the sharpest minds on Wall Street find it too difficult to guess where the market is going. So they suggest setting up a portfolio with a mixture of stocks, bonds and cash and sticking with it even amid market horror.
In Stovall’s view, that solid portfolio for a moderately conservative person saving for retirement would be divided roughly 60 percent in stocks, 25 in bonds and 15 percent in cash. The stock portion would have about 45 percent in U.S. stocks, or stock mutual funds, and 15 percent in stock funds investing throughout the world.
Keeping 60 percent of your savings in stocks or stock funds might seem foolish now given the nature of the current financial mess. So consider the words of Peter Bernstein, one of the most respected sages of asset allocation in the industry — one of the authors that financial planners read. I asked Bernstein if he’d have second thoughts now about sticking with a diversified portfolio of stocks and bonds when there is so much uncertainty about the financial poison in the worldwide economy.
He answered: “I don’t know which way it will go and when it will end, so I’m not changing my diversification.”
There’s a lot in that statement.
It means you don’t just stick with anything — let’s say a portfolio filled to the brim with financial and homebuilder stocks if you aren’t able to lose a good portion of your investment.
It means not worrying about Stovall’s model portfolio if you adopt it in your 40s. A more appropriate portfolio for a cautious person about to retire might be 50 percent stocks and 50 percent bonds.
Financial advisers have retirees cut back on stocks, often keeping about 30 percent when they’re in their 70s.
If you are in your 20s, 30s or 40s, any financial planner would tell you not to sweat it if you have diversified stock funds rather than a handful of stocks you picked on a whim.
There’s a reason: Although the stock market might fall 30 or even 50 percent, on average investors in the full stock market — the S&P 500 index — have recovered within 2 1/2 years from the bottom of the bear market, according to the Leuthold Group. It’s not always that soon, of course: People didn’t recover from losses in the Depression for more than 10 years, and after the 1973-74 bear market, it took 7 years.
Of course, there is no hint at this point if we are in an average bear market or something unusual.
“The sudden bankruptcy of Lehman Brothers over the weekend has led to another dangerous escalation of the crisis in the U.S. financial markets — a crisis that has been seriously harming the performance of the economy for over a year now,” said Brian Bethune, an economist for Global Insight.
Investors are clearly uneasy.
Even before the weekend’s dramatic events, they were parking large amounts of money in cash, or money market funds.
JP Morgan strategist Thomas Lee noted that $930 billion has been added to money markets since August 2007, exceeding the $600 billion raised in the previous bear market, in 2000-2002.
Still, Mark Zandi, chief economist for Moody’s , said he was encouraged that the Dow fell only 504 points Monday.
Although “several hundred banks” may still fail over the next year, he says he believes people are now aware of the problems, and that often means the economy is closer to the end of its problems than the beginning.
Stovall said now is probably not the time to move all your money out of stocks and into a money market fund. He thinks history suggests that losses going forward are probably going to be more moderate than those that have already occurred.
