It's a challenging market for investors ("CHALLENGING" means that you don't know what to do). If the stimulus package helps avoid recession, stocks should rise. If recession is already upon us, any rise will be false hope, because stocks would sink again. Paralyzed, we're reduced to platitudes: "It's too late to sell." "I buy and hold."
Buy-and-hold hasn't been a great solution. The market didn't recover much beyond the January 2000 peak. Over the past eight years, Standard & Poor's 500 stock index yielded a limp 1.66 percent a year.
On the other hand, trying to sell near the top and buy near the bottom doesn't work either, because you can't recognize those magic moments until they've passed. (There's a name for people who always jump in and out of the market at just the right time. They're known as liars.)
Fortunately, there is something you can do rather than stand helplessly by. You can diversify and rebalance. Both strategies add value and reduce risk. They also give you an action plan so you won't feel stuck.
When all the world's markets drop together, commentators like to claim that diversification doesn't work. They're wrong. Consider what's happened since the 2000 bubble burst.
While the S&P crawled, the MSCI EAFE index, covering stocks of the other developed countries, returned 5.3 percent a year, according to Morningstar, which tracks market data. Smaller U.S. stocks returned 10.8 percent. Emerging markets returned 15 percent. If you owned them all, you'd have shown reasonable results.
Aggressive investors often leave bonds out of the mix. Everyone "knows" they don't do as well as stocks. Well, here's a Wall Street surprise. Over the past eight years, intermediate-term Treasuries (maturing in one to 10 years) returned 6.8 percent a year—four times more than the S&P. As diversifiers, they worked, too, and brilliantly.
To diversify properly, you need to decide on an asset allocation—how much money to keep in stock funds (invested globally) and how much in bond funds. The general rule is to subtract your age from 110 and use that number as the percentage of your investments given to stocks. For example, if you're 40, your target should be 70 percent in stocks, 30 percent in bonds.
If stocks drop and are now worth less than 70 percent of your portfolio, sell some bonds and reinvest the proceeds in stocks at their lower price. When stocks rise, sell the portion that exceeds 70 percent and reinvest in bonds. Make these changes whenever your allocations get more than 5 percent out of line.
Rebalancing sounds simple, but it's hard emotionally. You have to take profits when stocks are hot and buy when they're in a funk. You won't do it if you're ruled by your hopes and fears. But if you shut your eyes and follow the formula, it will work. Professional investors rebalance regularly.
You can't work this strategy if you invest in individual stocks. Any one of them may be acting differently from the market as a whole. Allocators use mutual funds —ideally, index funds covering U.S. stocks and the universe of internationals. Life-cycle or target-date funds do the rebalancing for you.
It's simple to rebalance 401(k)s, IRAs and other tax-deferred accounts. You just move the money around. Taxable accounts are tougher because you owe taxes when you sell at a profit. Instead, rebalance slowly by putting all your new investment money into the asset that's fallen behind.
What might rebalancers do now? Sell bonds and lighten up on emerging markets while buying large international and S&P stocks. That's not a forecast. But for sure, markets that lagged will rise again.