On Oct. 18, the last time the Dow Jones Industrial Average fell below 10,000 before this month's bloodletting, Michael McMahan was upbeat.
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At the time, the certified financial planner with Raymond James Financial Services in Gastonia, N.C., said he was telling clients that the down market was a good opportunity to delve for some bargains. Five months later -- after the Nasdaq Composite shed a further 49% -- McMahan concedes that perhaps he was too optimistic. "We made a mistake advising them to go into what was a declining market," says McMahan. He explains that he became so enamored of the prospects for large-cap growth stocks that some of his clients' allocations to that segment climbed as high as 40% to 45%. That's a great deal higher than the 20% to 25% ceiling that he would normally recommend. Now amid another market selloff, McMahan says he's still optimistic that the market will bounce back, although he acknowledges that it may not be soon. He still thinks blue-chip tech companies like Cisco ( CSCO) and Sun Microsystems ( SUNW) are solid holdings, but warns that they may not pay off for another three to five years. Many investors who listened to financial planners like McMahan have suffered the slings and arrows of the market's outrageously bad fortune this past year. They are tired of hearing "buy and hold," especially since some advisers who were also saying "buy on the dips" haven't been proven right, and buying and holding many stocks means you're now holding about half of what you were a year ago. What's an investor to do now? For investors who have diversified portfolios that have been selected according to their time horizons, goals and risk tolerance, sitting tight, while frustrating, is probably the most prudent thing to do in a down market. According to fund giant Vanguard, one of the most common mistakes made by investors in the 1973-1974 bear market, when the S&P 500 fell some 48% between January 1973 and October 1974, was to sell and miss out on the returns when the market did turn around. Vanguard estimates that annual returns of the S&P 500 averaged 14.8% in the 10 years from 1975 to 1984, 16.6% over the 15 years from 1975 to 1989 and 17.2% over the 25 years from 1975 to 1999. "Studies have shown that if you miss the first five days of the recovery, it reduces your return to mediocre," says Jack Harmon, a certified financial planner with Harmon Financial Advisors in Atlanta. "We may not be at the bottom, but you're not going to be sharp enough or clairvoyant enough to time these markets."
What If You're Not Diversified?
Of course, that's if your portfolio is diversified. If your portfolio is overexposed in a volatile segment like technology, you should take steps to diversify as soon as you can. And if you're holding an unprofitable tech stock that once traded in the triple digits but now goes for less than the price of a pack of cigarettes, well, it might be time to bail. For McMahan, who said he has thankfully avoided speculative tech investments, getting his clients' growth allocations down to more reasonable levels is complicated right now by the market's low prices. McMahan, along with other planners, says one of the worst things investors can do in a down market is to dump losers to get into ultra-conservative holdings like money market funds. Another planner seconds that advice: "To take a large loss position and put it in a low-return scenario, there's no way in the world that that to me makes sense strategically," says Patricia Houlihan, a certified financial planner with the Houlihan Financial Resource Group in Oakton, Va. "Stay where you have an opportunity to recover." That's a very hard thing to do, especially at times when all of the lead stories on the major networks' nightly news reports are of the stock market's bloodbath. Indeed, the media's minute-by-minute reporting of market movements can make investors doubt their well-thought-out strategies. But many warn that getting out of the market in bad times will make it even harder for investors to reap the benefits when things turn around.
Watching Your Funds
That's not to say that you should be totally passive. Staying glued to the TV for the latest stock recommendation from the talking heads on CNBC is definitely not healthy, but you should be keeping an eye on your portfolio to make sure that your asset allocation isn't getting out of whack. If you own mutual funds, you should periodically review how they've been performing compared to their peers (information you can check out on fund tracker Morningstar's site). If a fund has been consistently underperforming, it might be time to move on. To gauge a fund's performance, "In a normal market, you would give a fund a good six to 12 months at least," Diahann Lassus, CFP and president of Lassus Wherley & Associates in New Providence, N.J. "In this kind of market, you want to look at both an up market and a down market, in this case how it's done over the past two years." Lassus is taking her own medicine: She says she's holding on to some of the funds that have disappointed her of late, like ( TSCEX) Turner Small Cap Growth , down almost 24% this year, compared to a loss of about 15% for its category, and ( JAOSX) Janus Overseas , down almost 12%, compared to a loss of around 9% for the foreign stock category, because she has confidence in the funds' managements and considers them solid long-term holdings.