Sit tight; it's no time to fidget

By Tim Middleton

As financial carnage worldwide grows to biblical proportions -- as in Armageddon -- shell-shocked investors have three choices.

One is to sell out and run away -- and stock exchanges have experienced heavy volume as many have opted for this choice. The second is to hunker down and do nothing, since what you own is already worth only a fraction of its intrinsic value. The third is to heed Baron Rothschild's advice and begin snapping up the bargains chaos is creating.

I recommend the middle way.

"We would not put (money) anywhere" at the moment, says Harold Evensky, president of Evensky & Katz, a money management firm in Coral Gables, Fla. "We have a policy in extraordinarily volatile periods that we'll wait."

"I don't think I'd invest fresh money right now," agrees Sam Stovall, chief investment strategist for Standard & Poor's Corp. Though major averages are down more than 20% from their peaks (even after bailout-inspired rallies late Thursday and Friday), "we still have more to go."

Even choosing to remain on the sidelines involves risk: A big money market fund has "broken the buck," chilling our faith in almost any refuge other than the mattress. That's why the Treasury on Friday said it would guarantee funds in money market accounts.

But surviving chaos doesn't require genius; patience will do. The most important financial decision you can make today is to ignore what's stampeding so many others. This, too, shall pass, and as it does you will find opportunity right behind it.

Safety first

This is not a garden-variety bear market we are experiencing -- the type that, on average, Standard & Poor's says produces a 27% total decline in its 500-stock index. Nearly a year into this one, nobody really knows the extent of the economic sickness that it represents. Last week, when Treasury Secretary Henry Paulson briefed bankers on the government's takeover of insurer American International Group (AIG, news, msgs), he confessed he and his colleagues at the Federal Reserve "don't have a clear sense of how big the problem is."

So this could be one of those bears that could reach or even breach the all-time records for losses of 40%.

In fact, the biggest issue facing investors immediately is how to protect their cash. Last Wednesday one-month Treasury bills briefly sold for a negative coupon. Unprecedented in U.S. history, investors were willing to pay more than $1 for a dollar's worth of T bill, locking in a guaranteed but at least known loss. Demand was so brisk the Treasury sold $40 billion more in bills than it needed for government operations.

This followed a giant money market fund, Reserve Primary Fund, breaking the buck, or reporting a net asset value of only 97 cents for each dollar on deposit -- only the second such time that has happened. The fund owned paper issued by Lehman Bros., the failed investment bank.

Some of the biggest money-fund operators, including Vanguard Group, Fidelity Investments and Charles Schwab, issued statements saying their money funds owned no troubled paper from issuers like Lehman and AIG. Money funds have total assets of $3.5 trillion.

Investment advisers are warning their clients to make sure their cash is in federally insured accounts. They usually pay miserly rates, but at least they are secure. At banks and even in most brokerage accounts you can lock in such guarantees with bank-issued certificates of deposit.

The downside? An upside

If indeed this bear stands to go down another 10% or more, running for the exits is a bad idea. Not only do you lock in paper losses, but you are apt to miss out on the eventual recovery, which could be explosive.

"I aggregated the S&P 500 behavior after the 1987 crash, the '90 credit crunch, the '98 currency crisis and the '02 technology bust, and what happens in the 36 months that follow is that the S&P quickly climbs 50%, most of that occurring in the first 24 months," says Jack Bowers, editor of the Fidelity Monitor investment newsletter.

"A lot of people are rushing for cash, but the ones who continue to bear risk, they're going to be paid for it," he says. "At this point, there is less downside risk than upside opportunity, if you take a two- or three-year view."

That is the view you should take in any investment account, but especially your 401(k). Even when global economic officials behaved stupidly in the Great Depression of the 1930s, investors were ultimately made whole.

Continued: Cheaper now, but risky, too

 1 | 2 | next >