Money Matters: Strategies After the Sell-Off
No doubt last week's market sell-off–which shaved more than 4 percent off the Dow Jones industrial average–has investors worried.
And the market's behavior on Monday offered little comfort. The benchmark Dow index bounced up and down all day, renewing fears that even if the market isn't headed for a major fall, it's probably in store for a big bout of volatility.
So what's an investor to do?
For starters, be patient. It's impossible to tell if this is the beginning of a new bear market or simply another head-fake, like the one stocks experienced in May 2006. Only time–and another round of economic data–will provide some clarity for Wall Street.
Keep in mind that last spring the stock market began a swoon that shaved about 8 percent off the Dow. Yet investors who fled the market in fear back then were left with an even bigger shock. Stocks came roaring back after the summer doldrums, gaining more than 12 percent from the end of June to year's end. If you fled the market in May, you missed out on another spectacular year of bull market gains.
It's a lesson for investors tempted to react quickly to last week's sell-off. Among other lessons to be gleaned from Wall Street's recent sell-offs and head-fakes:
Make sure you own a diversified mix of investments. This is the oldest advice in investing–and still the best. Take the bear market that started in March 2000. Leading into the sell-off, few investors saw the benefit of owning bonds. After all, when stocks were delivering gains of 20 percent-plus, why bother with an asset that was growing only in the single digits?
But as it turned out, bonds didn't just hold up well during the initial years of the bear market–they soared. The average long-term government bond fund gained a stunning 22.1 percent in 2000–and 16.3 percent in 2002, according to the fund tracker Morningstar. So investors should always own a balanced mix of stocks, bonds, and cash.
Cash isn't trash. The recent sell-off has driven investors into high-quality treasury bonds. This lowered the yields on 10-year treasury securities down to around 4.5 percent (bond prices and yields move in opposite directions). Yet you can earn slightly more–4.75 percent–in a virtually risk-free money market fund that doesn't tie up your money for a decade. And many bank certificates of deposit are paying out more than 5 percent. Remember that if you're looking for buying opportunities in falling stocks, you'll need some cash on hand to pay for those bargains.
Stick with larger, stable names. Sam Stovall, chief investment strategist for Standard & Poor's, asks this question: "In a storm, would you rather be sailing around in a battleship or a fishing boat?" Obviously, you'd want to be in the bigger, more stable vessel. The same principal applies to investing. So even though shares of risky small-company stocks have led the markets since 2000, this might be the time to concentrate your bets on blue-chip shares of giant, industry-dominating companies. The same advice holds true for those investing in foreign equities.
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