The Wall Street Journal-20080123-What-s a Small Investor to Do-- Five Good Reasons Stocks Are Attractive Despite Downdraft
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What's a Small Investor to Do?; Five Good Reasons Stocks Are Attractive Despite Downdraft
How do you keep your head, when all about you are losing theirs?
Yesterday, investors weren't at their finest. A tsunami of selling drove the Dow Jones Industrial Average down 464 points, only for shares to bounce back smartly, with the Dow finishing off 128 points.
Clearly, many folks are rattled. Looking to maintain your investment sanity? Breathe deeply, keep these five maxims in mind -- and start buying stocks.
-- Sitting pretty. Unless you're invested 100% in stocks, you haven't suffered the full brunt of the market decline.
Suppose you have a classic balanced portfolio, with 60% in stocks and 40% in bonds. While the Dow industrials are off 10% so far in 2008, your portfolio might have lost just 5%. Sure, that stings. But it is hardly cause for panic.
Moreover, the recent decline comes after five years of healthy gains. In fact, the shares in the Standard & Poor's 500-stock index are still up 69% since the October 2002 market low.
And remember, over the past five years, U.S. small-company shares and foreign stocks have easily outpaced the blue-chip stocks in the S&P 500. The bottom line: Despite the recent carnage, you are likely sitting on handsome profits.
-- Hitting bottom. A bear market is often defined as a 20% decline in stock prices. As of yesterday's close, the S&P 500 was down 16% from its Oct. 9 peak. In other words, if this turns out to be a standard bear market, the pain is almost over -- and there isn't much point in bailing out now.
Of course, this could turn out to be far worse than your standard bear market. Investors still vividly recall the brutal decline earlier this decade, when the S&P 500 tumbled 49% from its March 2000 peak to its October 2002 trough.
This sort of multiyear losing streak is, however, relatively rare. Since year-end 1925, we have only had four such losing streaks, 1929- 32, 1939-41, 1973-74 and 2000-02, according to Ibbotson Associates, a unit of Chicago investment researcher Morningstar.
-- Beating bonds. If you think stocks are unappealing, check out bonds and money-market funds.
As of yesterday's close, the benchmark 10-year Treasury note was yielding a modest 3.5%. That is a miserably low yield to lock in for the next 10 years -- and today's buyers may be left with little or no gain, once taxes and inflation take their bite.
Meanwhile, taxable money-market funds have lately been paying around 4%. With the Federal Reserve pushing down short-term interest rates, yields could fall sharply in the months ahead.
In fact, if you are an income-hungry investor looking for some inflation protection, stocks are arguably the best choice. For proof, compare the S&P 500 to inflation-indexed Treasury bonds.
Today, you can purchase 10-year inflation-indexed Treasurys, garner a 1.3% initial yield and see your interest payments rise along with inflation in the years ahead. The recent rally in inflation-indexed bonds suggests investors think that's an attractive deal.
Yet if you want a rising income stream, the S&P 500 strikes me as a far better bet. True, the S&P doesn't come with a government guarantee.
But you have a higher initial yield, currently 2.1%, and there's a good chance your income will outpace inflation. Over the past 50 years, the dividends kicked off by the S&P 500 companies have risen at 5.6% a year, comfortably ahead of the 4.1% inflation rate.
-- Staking claims. Most investors buy stocks not for income, but for capital gains. At times like this, price appreciation can seem utterly fickle, as shares bounce up and down with the shifting mood of investors.
But over the long haul, shares should post handsome gains, because they represent a claim on corporate profits. Yes, those profits may suffer temporarily if the economy slips into recession.
Eventually, however, growth will return, and that growth will drive share prices higher. Over the past 50 years, the economy has expanded at a 7% annual clip. Sure enough, share prices have followed right along, also climbing at 7% a year.
-- Buying cheap. The further stocks fall, the riskier they seem to investors. But in reality, the decline makes stocks less risky, because they are now almost certainly a better value.
Think of it this way: If the S&P 500 is any guide, your fellow investors are saying U.S. corporations are worth 16% less than they were three months ago. A slowing economy means corporations probably are worth a little less. But surely they aren't worth 16% less.
My advice: Calculate what portion of your portfolio is in stocks and stock funds. After the recent market carnage, you likely have far less in stocks than your original allocation called for -- which means it's time to start buying. What if stocks keep falling? You keep buying, so you maintain a full stock-market weighting. That's what I plan to do.
(See related article: "Market Drop, Fed Cut Create Opportunities For Cherry-Pickers" -- WSJ Jan. 23, 2008)
