After The Fall: What To Do Now

8/15/2011


Stocks around the world have been hit by panic selling, pushing the Dow Industrials down 15% in three weeks. Here's what we think you should do now, in four parts:

First, don't panic. If you let emotions like fear and greed and remorse drive your investment decisions, you'll always be reacting to the market's latest swing. In today's fast-moving markets you don't have a lot of time to ponder buy and sell decisions. But your long-term results are likely to benefit if you carve out some quiet time to deliberate on your investment goals, risk tolerance, and view of the market.

Second, raise some cash. With the Aug. 2 bear-market signal under the Dow Theory, we downgraded four stocks and lifted our buy lists' exposure to a short-term bond fund. This week we're dropping two Long-Term Buys and adding one new Long-Term Buy.

We're also cutting the target weight on each of our stocks by 0.1%, putting our bond-fund position at 24.2% for the Buy List and Focus List and 26.3% for the Long-Term Buy List. To limit trading commissions, use some common sense and trim selectively, cutting exposure to stocks where your positions are relatively large. Avoid big bets on a single stock or single industry.

We remain comfortable using Vanguard Short-Term Investment-Grade ($10.78; VFSTX) for our short-term reserves. The fund, yielding 1.6%, has held up well amid the recent market tumult. In fact, we're adding the fund to our recommended mutual-fund portfolios. We've trimmed our exposure to stock funds, especially small-company funds, with the proceeds going into bond funds.

Third, consider how you are going to react if the market takes another tumble. Before betting, good poker players consider what they're going to do if somebody raises the stakes. Will they be forced to fold? Similarly, you need to consider whether you have the fortitude to weather another decline. If you think you might panic and sell if the market falls another 10% or 15%, your stock-market exposure is probably too high.

Remember, the 24% to 26% bond-fund position of our buy lists is a partial, tactical hedge. We don't try to avoid bear markets entirely, partly because all-or-nothing timing is among the best ways to destroy your long-term returns. We are unlikely to ever have less than 60% of our buy lists in stocks, so set your long-term equity allocation with that knowledge in mind.

Fourth, stay engaged. While watching the stock market is not nearly as much fun during bear markets, you're not investing for fun. So, keep looking for buying opportunities and selling opportunities, and strive to limit your portfolio to your best ideas. Relentlessly look for ways to upgrade your portfolio.

Don't be reluctant to sell a stock just because it is below your purchase price, and don't be afraid to buy a stock simply because its price might fall in the near term. If you are underweight in equities right now, Apple ($374; AAPL) and IBM ($171; IBM) rank among our top picks.


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