Wednesday, 29 Oct 2008
The averages just wiped out the entire 2003 - 2007 gain. If you got burned in the Internet bubble and then were slow to get back into the market, chances are you are upside down again. Fixing a damaged portfolio is the most difficult of all. Without first realizing what went wrong, another quick fix will only carry you to the next debacle.
Why did things get so bad so fast?
Crowds are only drawn to things big. A 10% decline is not newsworthy. If nobody talks about it, it’s not really happening. So people are not worried. But when we got into bear territory, the media had a fest. The last time people were too slow to get out: they simply did not believe that things could get THAT bad. Now they’ve learned their lesson, so everyone rushed to the exits at the same time.
The statement that there are more sellers than buyers in a down market is not correct. There is a buyer for EVERY seller. It’s how eager the buyers are to buy or sellers are to sell. In a declining market the buyers are in no hurry, whereas sellers will take any price. NOW.
So the first lesson is:
Pay attention to market cycles
and get out while the getting is good. Well, that’s easier said than done. Some would say that if you are within five years of retiring, switch to a more conservative asset mix. That’s not good either. Suppose you were within five years of retiring in 2003. Switching out of equities would have kept you out of some of the best real estate and stock markets for the past five years. Sure, right now you would be glad you did, but could you have gotten out in 2006 or 2007? Or what if, on the other hand, you are within five years of retiring now? Is now a good time to switch out of stocks (provided, there is anything left to switch out of)?
Putting arbitrary time frames without regard to the market cycle does not make sense. If market timing does not appeal to you either, the simple rule may be: take some profits off the table periodically, while you have them, and lock in the gains in some conservative vehicles. Those who trade small caps know that each leg up in the market produces a new crop of leaders. Each time the market had an intermediate top, followed by a correction (as it did in 2004, 2005, 2006, and 2007), many of those leaders sold off too. If you locked in your gains each time, you would have kept most of them and been largely in cash by now.
Well, that was then, and may be a good lesson for the future, but the question still is:
What now? To sell or not to sell?
Step 1: take charge of your finances;
Step 2: learn.
It’s your money. You can’t blame or sue your way out of a hole.
Watching your retirement fund shrink is painful. But selling is what drives the stock prices down. If you sell, you will contribute to the decline. If you don’t, others like you will drive the prices down anyway. Darned if you do, darned if you don’t.
Another problem with selling now is that you might be selling at the bottom. Bottoms are reached when everyone who wanted to sell has sold. If you sell at a loss, chances are you will once again be too slow to get back in. Another “buy high / sell low” cycle.
Dividend income
One solution may be to reposition your assets. Some dividend paying funds like DVM or UTF are yielding in excess of 15% and selling at a 15% discount to their NAV. Both offer a monthly payout. (Disclosure: I use both in my own retirement accounts but this is not a solicitation or recommendation - just a starting point so that you know where to look. There are other vehicles offering good equity income). The assets are invested in the beaten down sectors: banks, REITs, utilities. They may still have casualties along the way but generally these sectors don’t go out of business: the media may be busy peddling doom and gloom but your bank still wants you to pay your mortgage, you are still paying your utility bill, and the grocery store still has to pay its rent.
Having the bulk of your retirement assets in dividend paying stocks creates a rising income stream because many companies increase dividends faster than inflation. The key is not to go after the highest yielding stocks but the ones that have a history of dividend increases. There are funds (like DVM or UTF) that specialize in those types of stocks. If you put your fund on DRIP (dividend reinvestment plan), you will be almost glad the market is down because you will be buying more shares with those juicy dividends. If you take the income - well, that’s 15% income.
Now, a 15% dividend is pretty high. But that’s an aberration. Historically, these funds yield around 6% (with some leverage). In this debacle they are oversold. Well, so are you, so to speak, but dividend payers have a better chance of coming back, so even if you have to take a loss, you can lock in high monthly income for now and capital appreciation for later. Just don’t expect the new funds to go up as soon as you buy them.
Slav Fedorov is a full time stock trader and founder and managing member of TradingZoom, LLC - a provider of timely stock picks in small caps based on proprietary selection methods.
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