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The continued decline of the Dow Jones Industrial Average ($INDU, news, msgs) leaves investors with a big question: What to do next?
But this is no time to panic. Market corrections are an opportunity to upgrade the quality of a portfolio on the cheap. In panics, everything gets whacked. Only later, as they sift through the carnage, do investors discover that plenty of good stuff has been thrown out with the bad. The truly bad, meanwhile, gets worse.
If you've been prudent, you've built up some cash to take advantage of a correction that has been widely predicted. If not, the time to act is now. You don't need to take drastic action: A correction is short-lived by its nature, and stocks remain the likeliest assets to perform well in the next few years.
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Here are some simple do's and don'ts.
Do:
- Lower your risk profile. In a correction, "you want to sell the assets you're least comfortable with," notes David Ellison, the chief investment officer of FBR Funds. "If you think they're risky, get rid of them." Among domestic stocks, the likeliest candidates are real-estate investment trusts, which have trebled in recent years. Other vulnerable groups could include microcap stocks, which are hypersensitive to the economy, and communications funds, which have been buoyant after being crushed at the end of the 1990s, the last time there was a panic. Overseas, the target is even more obvious. Emerging markets get pneumonia when the global economy sneezes. Fixed-income investors will shun mortgage bonds, high-yield bonds and the debt of developing countries.
- If you do sell assets, hold on to the proceeds in a money-market account or Treasury bills. You are going to want this money pretty quickly, depending on events, because stocks are the best place to be, even when they're correcting.
- Watch for bargains to develop among the kind of blue-chip companies that have proved resilient in past market tempests. Health-care mutual funds are a great place to start looking. So are technology funds, because a market panic isn't a capital-spending panic; blue-chip stock funds in general; and foreign-stock funds, particularly those with plenty of exposure to long-suffering Japan.
- Stick with high-growth companies, like the midcaps I recommended in my column of Feb. 27. Post-correction buyers are going to be looking for winners, and this is a winning bunch. Ditto blue-chip growth.
Don't:
- Rush into bonds. What's the profit? Corporate bonds and high-quality municipal bonds are already delivering misery yields. As one of Pimco's bond gurus, Paul McCulley, pointed out in my book "The Bond King," "The upside of a bond is that you get your money back." Investors own bond funds to cut risk; you own them always, not selectively. If bond yields were 8%, they would look interesting; below 5%, they aren't worth a second look.
- Waste time on traditional havens such as gold, real estate or commodities. Those markets have enjoyed massive multiyear rallies that have already filled them with risks of their own.
- Be scared into bear-market funds. Despite benefiting from the worst bear market in a generation from 2000 through 2002, the average bear-market mutual fund declined an average of 7.1% in the 10 years that ended Jan. 31.
Longer term, you might decide this long-in-the-tooth stock rally could use a few buttresses in your portfolio. Here are some to consider:
- Long/short funds. As I described in a column in January, these funds play down markets as well as those with the usual upward tilt.
- Market neutral funds. Some funds hedge away from stock risk. One group I described last August are merger funds, which scalp some of the premium in corporate acquisitions.
- Permanent Portfolio Fund (PRPFX). As I noted in November, it has almost no exposure to stocks.
Other than that, take advantage of the correction to exchange some of your lowest-quality assets for some of the highest quality. When normal times return, you'll be sitting pretty.
At the time of publication, Tim Middleton didn't own any securities mentioned in this article.
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