5 Ways To Handle A Tricky Market

Quoted on
Fidelity.com (10.29.09)
5 Ways To Handle A Tricky Market
By Roger Fillion

You sold your stocks in the past year because of Wall Street’s plunge. Your cash is parked in a money-market fund earning practically nothing. Now you’re wondering what to do, watching from the sidelines as Wall Street posts one of its most powerful rallies in 70 years.

You’re certainly not alone. There is about $3 trillion in cash sitting on the sidelines – enough to fuel a further rise in stocks. Experts agree it’s a good idea to put at least some of your money back to work to build equity and protect against inflation over the long term. But how?

The truth is there is no “one size fits all” model here. Much depends on your comfort level with investing and, perhaps more importantly, when you’ll need to use the money. Is it for retirement, or something more immediate, like buying a new home?

“There’s no perfect answer for how an individual should get back into the market, because every individual has their own risk-tolerance level and financial situation,” said Bobby Straus, chief investment officer at ICON Advisers Inc., a mutual fund company in Greenwood Village, Colo.

You may even want a financial adviser to help with the difficult task of matching your investments to your personal goals.

“Coming out of this market environment, people need to be honest with themselves about their comfort level with the day-to-day volatility that different investments have,” said Chris McDermott, Fidelity’s senior vice president for investor education and financial planning.

Investors were stunned as the Dow Jones industrial average tumbled from a high above 14,000 two years ago to a low of about 6,500 in March. A rally has since carried the Dow back near 10,000, but many investors, sidelined by the volatility, find themselves missing the upturn.

McDermott said it’s important to stay focused on your long-term goals and stick with a plan. “The key is to get invested and have the discipline to remain invested.”

Once you’ve picked a mix of assets appropriate for your age, retirement timeline, risk tolerance and other factors, such as how much income you’ll need in retirement, you’re ready to get back into stocks. Here are five ways to do it:

1. Jump back in all at once. “By being fully invested from the start, we can enjoy all the potential gains” stocks can provide, according to Gregory Singer and Ted Mann, analysts at Bernstein Global Wealth Management, a unit of AllianceBernstein LP.

“Setting aside the risk tolerance issue, it’s always best to put your money in yesterday – all at once yesterday,” said Clint Edgington, president of Beacon Hill Investment Advisory, a fee-only investment advisory firm in Columbus, Ohio.

But that’s not easy for everyone, especially after last year’s financial crisis.

In a recent article in the CFA Institute’s online newsletter, Singer and Mann at Bernstein Global Wealth noted that over the last 80 years the stock market has risen more than 70% of the time. “The odds that the market will outperform cash are in our favor,” they wrote.

Singer and Mann said the stock market’s average gain in all the rolling 12-month periods from January 1926 through November 2008 was 12%. A strategy known as dollar-cost averaging, or investing a set amount each month, returned 8%. Staying in cash returned 4%.

And this is going back to when people parked much of their money in “passbook savings” accounts. Rates today for similar short-term holdings are at historic lows, usually 2% or less.

2. Dollar cost average. Even if jumping back into stocks feet first tends to produce the best returns over time, it’s not for everyone. Some investors may lack the stomach to pour tens or hundreds of thousands of dollars into stocks all at once. In that case, dollar cost averaging may be the ticket.

“That’s always a sound strategy that gives investors an opportunity to get the average cost over a ‘period of time’ rather that just ‘today’s price,’ and it works especially well during sideways and volatile markets,” said Wes Moss, chief investment strategist at Capital Investment Advisors, a fee-only advisory firm in Atlanta.

Many investors are familiar with the strategy, but here’s a brief refresher: Invest the same amount each month, spreading your purchases across the market’s ups and downs over a period of many years.

To put this strategy to work now, think about committing your cash to stocks over three to 18 months, depending on how comfortable you are with risk and your overall financial situation. True, you may miss out on some gains as you “average in,” but you’ll limit your losses if the market retreats.

“It reduces the volatility of your returns while getting into the market. But it also reduces the returns you can expect during that time period as well,” said Beacon Hill’s Edgington.

3. Take “baby steps.” “A lot of people were shell-shocked by what happened last year. They were too scared to pull the trigger and get back into stocks,” said David McPherson, a fee-only financial planner and principal of Four Ponds Financial Planning in Falmouth, Mass.

His advice: “Start with some baby steps. Invest in some conservative bond funds a little bit at a time.”

McPherson advocated funds that invest in short-term, investment-grade corporate bonds with a one- to three-year maturity. This should help bolster returns and calm your stomach, so you’ll eventually feel better about buying stocks again. “I look at it as a way to build confidence,” said McPherson.

4. Don’t just stash it in cash. This may be prudent if you expect to buy a house soon. But experts don’t advise keeping all your money in cash for the long term, particularly if you don’t need the funds for at least five years.

Singer and Mann, in their article, said holding cash “did not come close” to the returns earned over time from investing in stocks, all at once or via dollar cost averaging. “You’ve got to keep pace with inflation over the long term,” added Fidelity’s McDermott.

But if you do decide to take a more conservative approach, there are ways to help keep inflation from eroding the value of your cash. One is to buy U.S. Treasury Inflation-Protected Securities, or TIPS, whose value is adjusted based on the Consumer Price Index, the government’s main inflation gauge. Another is bonds and bond funds, which provide yield. But beware: These investments can fall in value when interest rates rise.

5. Don’t try to time the market. Maybe you think the market’s run-up since March is going to evaporate, and you’re waiting to pick the bottom. Good luck.

“We have yet to find a person on record who has consistently and perfectly picked the bottom to invest and then gotten out at the top,” said ICON’s Straus.

So there is no one-size-fits-all solution.

If you can stomach short-term losses, getting back in all at once may be for you. Otherwise, consider a gradual approach, perhaps even baby steps. Over the long haul, though, one thing is clear: Getting back into the game is better than sitting on the sidelines.