After a Plunge, Balanced Funds Can Lift You Up

NEW YORK (TheStreet) -- September and October have traditionally been the worst months of the year for stocks. The S&P 500 fell 10.9% in September 2002 and 16.8% in October 2008. This year, odds are good that another seasonal dip will occur. With the economic outlook uncertain, any setback could send investors running.

If stocks plummet, should you buy? Yes, says Dan Wiener, editor of The Independent Adviser for Vanguard Investors newsletter. Buying on dips has long been a successful strategy, he says.

Wiener studied the market going back to 1983 and found that there were 50 instances when the S&P 500 lost 3.5% or more in a single day. In 41 of the cases, the market recorded gains in the following 12 months. The biggest one-day decline occurred Oct. 19, 1987, when the S&P lost 20.5%. In the next year, the market gained 27.0%. After losing 9.0% on Oct. 15, 2008, the S&P gained 24.1% during the next 12 months.

To take advantage of big downturns, investors with diversified portfolios should put money into all their stock holdings. But some funds are especially safe ways to bet on a rebound. Wiener looked at how individual Vanguard funds performed following the big down days. Among the best performers were balanced funds, which hold mixes of stocks and bonds. The fixed-income stakes provided protection because bonds stay in the black most of the time.

Consider Vanguard Wellesley Income(VWINX), which keeps about 60% of its assets in bonds and the rest in undervalued blue chips. Current holdings include Home Depot(HD) and E.I. du Pont(DD). Wellesley recorded a gain in each of the 12-month periods that followed a big one-day loss. On average the fund gained 15.9% during the recoveries.

Another top choice was Vanguard Wellington, which has about 40% of assets in bonds and 60% in unloved dividend-paying stocks. Holdings include AT&T(T) and United Parcel Service(UPS). Wellington stayed in the black in all but two of the 50 recovery periods and delivered an average gain of 20.0%.