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Never Sell Into a Panic

Terry Savage

Having received more than a few emails asking that question, it's only fair to give an honest response. That is: "I really don't know." And no one else does either. The fall-back position is that old Savage Truth: "Sell down to the sleeping point." But never sell into a selling panic.

No market goes straight down. There's bound to be a "bounce" -- somewhere. That's when your self-discipline will come into play. Then there will be a huge temptation to just give a sigh of relief and forget the pain of a couple of huge down days. Just as there is currently the temptation to cut and run.

Over the long run -- at least 20 years -- history says you'll come out ahead with a well-diversified portfolio of stocks. But we each have a different time horizon and a different risk tolerance. That's why you have to take a step back and assess the reasons for this market decline, your current positions and your ability to stay calm under the mounting pressure of losses.

And that's where "chicken money" comes in. Of course, regular readers of this column already have their quotient of "chicken money." That's Treasury bills (bought online through TreasuryDirect.gov) as well as short-term, FDIC-insured bank CDs and money market deposit accounts.

Money market mutual funds qualify as well, but you may want to choose those that only invest in Treasury securities, such as (CPFXX)American Century's Capital Preservation Fund (CPFXX) (Treasuries only) or the (VMPXX)Vanguard Treasury Money Market Fund (VMPXX) (80% Treasuries and some government agency bonds).

Having some "chicken money" gives you the confidence required to get through the declines.

The subprime mortgage crisis has brought this forgotten bit of investing wisdom back into focus. Short-term rates this past week took their largest one-week decline in years as investors ran for cover. At week's end, 90-day T-bills were yielding only 3.28%.

The Federal Reserve's move on Friday to cut the discount rate only confirmed that individuals and institutions were rushing to safety, forcing the Fed to act decisively to calm the credit markets.

Subprime mortgages are like pollution. A little drop of black ink in the pool will certainly spread throughout the water, and you'll never notice. But pour a bottle of ink into the water and suddenly everything turns grey. That's what's happened with subprime mortgages, as financial institutions around the world discover that their assets are polluted with mortgages made to people who are now in default.

Lenders plan for relatively few loans to go sour. That's part of their standard risk calculation. The money they make on the good loans is designed to far offset the losses on the bad.

At least that's the way it worked in the "good old days," when bank officers looked the borrowers in the eye, judged the risk and kept close watch on the payments.

All that changed when mortgages became "securitized" -- put into pies that were sliced into pieces, and sold off to financial institutions that were looking for a stream of income. These slices or "tranches" even received ratings from the bond rating companies on the basis that "pooled risk" minimized the potential for loss.

In effect, the idea was that spreading the risk would lessen the risk of pollution. But just like the bottle of ink, the questionable loans grew inside the mortgage securities, and spilled into the waters of the credit markets. Now it will color the balance sheets and earnings statements of a broad array of institutions, ranging from domestic mortgage brokers already in bankruptcy to large U.S. financial institutions and now global banks.

In fact, the pollution is now being "diluted" by the world's central banks, ranging from our Federal Reserve bank to the central banks of Japan and Canada, which are busy pumping in more credit to the system to wash away the stain of those bad loans that are rising to the surface of credit portfolios like dead fish in a polluted pond.

The immediate impact is to alleviate the crisis. Interest rates on the safest securities are already falling. One day, all this newly created credit will have the opposite impact -- raising fears of inflation and thus pushing U.S. interest rates higher. But that's for later. Right now, it's a rush to the security of the highest quality. And that's defined as short-term Treasury bills and notes.

Having a portion of your investments in "chicken money" gives you the courage and discipline to ride out the volatility of the stock market. Remember, market tops -- and bottoms -- are made by people acting irrationally out of emotion. And that's The Savage Truth.