In This Chaotic Market, Stay Steady With These Solid Investing Tenets

~ By Anne Kates Smith
~ Kiplinger’s Personal Finance

What are we supposed to make of this whiplash market? I’m certain that the only sane way to play the crazy ups and downs is to hold fast to the investing tenets we at Kiplinger have preached for years (that’s why they’re tenets).

Among them:

Most investors are lousy market-timers. So don’t attempt it, period. Take a look at a couple of the worst months for mutual fund net redemptions on record: In October 1987, investors withdrew 3.6 percent of stock-fund assets, and in July 2002, the net outflow was 2.05 percent, according to the Leuthold Group, a research firm in Minneapolis. A year after investors bailed, the Standard & Poor’s 500-stock index was up 10.8 and 8.6 percent, respectively. The two-year gains were 35 and 21 percent, respectively.

Calling market bottoms is a futile exercise. The stock market typically bottoms just past the midpoint of an economic downturn. One year past the trough, the average gain — dating back to 1892 — is nearly 44 percent, says Leuthold.

It’s all about buying low and selling high. No need to fixate on market legends such as Joe Kennedy or Warren E. Buffett. Regular folk can ensure they are buying low and selling high by dollar-cost averaging and rebalancing their portfolios.

By Definition, dollar-cost averaging (investing the same dollar amount in the market at regular intervals) gets you more shares when prices are low and fewer when prices are high. Just as important, and maybe more so, averaging forces you to keep putting money into stocks (or stock funds) when you might otherwise not do so — that is, when share prices are falling. If you are contributing to a 401(k) or other similar plan, you are dollar-cost averaging.

No market is a monolith, so you have to diversify. The stock market’s dismal performance this year has challenged the conventional wisdom about the desirability of diversification. Just about every sector and every foreign stock market has sunk. Most segments of the bond market have lost money, too, although it has been possible to eke out a positive return by investing in Treasury bonds.

My guess is that this year will turn out to be an anomaly. So I stand by the tried-and-true formula of maintaining a diverse portfolio, which you can achieve by investing in a mutual fund that is pegged to a broad index, or by holding a mix of funds, including those that focus on small-company stocks, large-company stocks, stocks of fast-growing companies, bargain-priced shares, international stocks and so on.

For a graphic illustration of how important diversification is, visit http://www.callan.com/research/institute/periodic, which has a color-coded periodic table of investments. You’ll see, for instance, how dangerous it would have been to load up on small-cap stocks in 2007, even though they beat blue chips in seven of the previous eight years.

It’s probably not — I repeat, not — different this time. Just as I question the way people rationalize prices that reflect a bubble at the top of a market, I’m suspicious of claims that this bear market is “different.” It might be worse, but it’s not the first deflated bubble, or the first downturn exacerbated by leverage and derivative securities, or the first time the government has come to the rescue.

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