PERSONAL FINANCE COMMENTARY

Panic-Proof Your Portfolio in 5 Minutes

By Dan Caplinger
October 6, 2008

Lurking in your mailbox, something scarier than the most ingenious Halloween decorations waits for you: your quarterly statements.

You already know they’re not going to be pretty. Unless you dumped everything into ultra-safe Treasury bonds before the choppy market turned into a hurricane, you're going to see some pretty serious losses in your portfolio. Take a look at just a few of the hardest-hit stocks in the past three months:

Stock

13-Week Return

AIG (NYSE: AIG)

(85.3%)

Dynegy (NYSE: DYN)

(63.5%)

McDermott International (NYSE: MDR)

(63.7%)

Nortel Networks (NYSE: NT)

(71.8%)

Petrohawk Energy (NYSE: HK)

(65.5%)

Sirius XM Radio (Nasdaq: SIRI)

(69.8%)

Mosaic (NYSE: MOS)

(69.1%)

Source: Motley Fool CAPS, as of Oct. 3, 2008.

Granted, most people haven't lost quite that much in their overall portfolios. But even if you dodged all those bullets, the quarter's results are sure to come as a shock -- especially for those unaccustomed to seeing any losses at all. Since the end of June, the S&P 500 and the Nasdaq both fell more than 15%, while the Dow fell about 10%. International stocks took a much harder hit -- a broad world index was down 20%, while many emerging markets were down 25% to 30%.

As painful as the past quarter has been, the future seems even more uncertain. Whether the recent $700 billion rescue bill will work is anyone's guess. Over the weekend, Europe started making its own plans to shore up confidence in its own financial institutions. Here in the U.S., bad employment numbers have many worried about their jobs.

In the face of all that uncertainty, what should you do now?

Five cures for statement shock
When the world has you on the edge of panic, your best bet is to take a rational approach to the situation. By spending a few minutes checking on some essential things, you'll get the confidence you need to avoid major mistakes.

1. Check your emergency fund.
Now more than ever, having cash available is essential. Although three to six months of expenses is typically enough during normal times, saving more as an insurance policy against unemployment or other emergencies can help you sleep better at night.

2. Check your contributions.
Nobody feels good about putting money into the stock market when it's dropping like a stone. Yet when stocks are cheap, you should consider putting more money than usual into the market. By the time the current troubles end, you can expect share prices to be much higher -- so getting in while the getting's good will likely prove to be the smartest move.

3. Check your allocation.
If the falling market has convinced you that you're not as risk-averse as you thought you were, then leaving your asset allocations alone may work best for you. Otherwise, though, the market drop has probably left you with a smaller-than-normal allocation to stocks. If you still have a long way to go before you need your savings -- and you can handle the current stress -- then rebalancing into stocks increases your risk but also increases your potential return when shares rebound.

4. Check on new opportunities.
If you've ever complained that a particular stock was too expensive, look again -- you might be surprised. Google fell below $400 last week to hit a two-year low, and Apple dropped under $100 for the first time since early 2007. Take a second look at stocks you've tracked in the past and see if they suddenly make sense again.

5. Check yourself.
As the market drops further, the urge to panic will build. Unfortunately, there's no easy solution for your losses: The only way to get that money back is to stay invested and look for better long-term results.

Bear markets are never easy. But in hostile market environments, losing sight of your long-term strategies is a surefire path to disaster. By panic-proofing your portfolio, you'll put yourself in a position to ride out whatever the market throws at you.

More on fear and loathing in the financial markets:

cheap stocks.Some great investments for the downturn.Did you make a mistake buying stocks?

Is It Time to Run and Hide?

By John Rosevear
October 6, 2008

Yay, the bailout passed!

Boo, the markets are still tanking.

An acquaintance of mine is a professional technical analyst, meaning that he analyses the patterns of past stock and index price movements to gain insights about what's likely to happen next. He says that his various metrics suggest that the red-number days will continue until the S&P 500 hits 950 or so, at which point the market has a good chance of starting its recovery.

As I write this on Monday morning, with the S&P a bit above 1050, that would mean another 10% decline from current levels. A scary prospect in normal times, but right now, that sounds almost like good news. Heck, given the size of the drops on recent days, we could be off and rolling on a new bull market before the end of the week!

It's too bad that, like my fellow Fool Selena Maranjian, I'm skeptical of technical analysis. It's possible that the bottom isn't far off, but I suspect that tough times will be with us for a while. Even if the market starts to recover -- to be fair, I have no idea when that is likely to happen, and neither do most "experts" -- the economy looks like it's going to be ugly for some time yet.

What do we do now? Is it time to bail out and preserve the capital we have left?

The pros and cons of selling
If the volume of emails I got after last week's article advising people to hold the course is any indicator, a lot of you are worried about on-paper losses to date, and concerned about much worse to come.

Those recent losses, of course, have come pretty much across the board, whether you're holding blue-chip stocks like Dow Chemical (NYSE: DOW), promising midcaps like II-VI (Nasdaq: IIVI) that were just starting to pop when they got caught in the market's downdraft, or seemingly great small caps like Volcom (Nasdaq: VLCM).

While a few stocks have thus far escaped the worst of it -- McDonalds (NYSE: MCD) and Wal-Mart (NYSE: WMT), two companies that can be expected to do well in a tough economy, come to mind -- the damage has been pretty widespread. And while that damage is scary, it's also a compelling argument for holding on.

If you sell now, you avoid further losses in the investments you sold. On the other hand, you lock in the losses you've already taken. Right now, those losses don't exist except as a matter of bookkeeping. If the stocks you're invested in -- either directly or via stock mutual funds -- are fundamentally sound, the prices should eventually recover. Assuming you're investing for the long haul, for a retirement that is 10, 20, or 30 years away, you have time to ride this out.

The worst damage may already be done
Some of my correspondents insist that things are different this time, that this isn't a "normal" bear market, that the global economy really is going down a deep hole for the next several years, that many companies will die, and that the stock prices of the remainder will be moribund for a decade.

I can't say for sure that they're wrong.

But I do have a sense that the odds favor them being wrong. We'll likely face a tough bear market and a recession, sure, but not a disaster. The credit markets will get themselves unstuck, soon, because the consequences of staying stuck are incredibly dire. Regulators and central banks will do the ugly things that need to be done. Money will start moving, the TED spread will shrink, and the world will tighten its belt for awhile, but life will go on.

And at some point in the coming days or weeks or months, probably when things look absolutely awful, the stock market will suddenly turn and start rising. And it will keep rising, steeply. Eventually investors will accept that a new bull has been born. And they'll start buying accordingly, because that's what people do when prices seem to be going up.

If you want to own something defensive in the meantime, you could always put a little money in gold or in a bearish ETF -- though you should be careful. But you'll need great market-timing skills to sell that investment and "go long" at the appropriate moment, and market timing is a dubious science.

You might be better served by doing what I've been doing -- buying beaten-up blue chips like Merck (NYSE: MRK) and Coca-Cola (NYSE: KO) that have a good chance of sustaining their dividend payments through a recession, and waiting for the tide to turn. Even if the stock price falls, you'll still be making money (via those dividends) -- as long as you don't sell. And in a market where 10% down is the "new breakeven," a 2% dividend looks like a really good return.

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