WHERE YOU ARE: A 51% rise in Standard & Poor's 500-stock index since its March bottom has lifted your balances, but you're still not much better off than you were five years ago.
WHERE YOU WANT TO BE: In the market again, but with a reasonable degree of safety.
HOW TO GET THERE: Despite the rally in stocks, plus signs that we are pulling out of the recession, investors are fighting the last war. In the six-week period that ended July 29, U.S. investors added just $6.8 billion to stock funds (net of withdrawals) but $41.7 billion to bond funds.
It's time to abandon the bunker mentality and start investing for more-normal times, as Jed Richardson has done. At one point in 2007, Richardson, a 39-year-old banker from San Francisco, yanked so much of his money out of stocks that he was out of the market entirely except for shares of his own company. Last winter he concluded that cash might be safe, but it's a poor strategy for growth. So he began filtering his 401(k) contributions back into stock funds. With the market coming back, Richardson now has 55% of his portfolio in stocks.
To prepare for life after a paycheck, Jerry Boyer, a retired lobbyist who lives in Spearfish, S.D., adopted an austerity program so strict that he and his wife, Carol Koerner, postponed vacations for ten years, drove old cars and eliminated debt. Boyer, 66, also hoarded cash and short-term bonds. Last November, his financial planner in South Dakota, Rick Kahler, helped Jerry relax enough to start a program of putting money into stock funds in equal monthly amounts.
You can take a tip from Richardson and Boyer about how to get back in the game: a little at a time. Boyer, for example, dusted off the time-tested strategy known as dollar-cost averaging. Regular monthly stock purchases take the emotion out of investing and stop you from pulling out with undue haste (see the box below).
Adjust your risk. Prior to the meltdown, someone Richardson's age would have been advised to invest at least 65% in stocks or other growth-oriented investments. And Richardson still thinks that a 75% stock allocation is appropriate for him. Nevertheless, he's limiting his riskier investments because his total compensation is uncertain and his wife, Preston, is now at a lower-paying job. If his family's finances are looking up by the end of 2009 or early 2010, he'll increase his stock allocation.
Take a look at all of your investments and see if they still meet your needs and your tolerance for risk (a good Web site for this is www.riskgrades.com). Trim anything that is too high a percentage of your total portfolio -- more than 10% for a single stock or 20% for a mutual fund, unless it's a broad index fund such as Vanguard Total Stock Market (symbol VTSMX).
Still feel you have too much in stocks? Sell some of your holdings and replace them with bonds, such as Kiplinger 25 mainstays Harbor Bond (HABDX) for money in tax-deferred accounts and Fidelity Intermediate Muni Income (FLTMX) for money in taxable accounts.
Toss the lemons. While you're taking inventory, see if each fund ranks among the best of its kind, has an experienced manager and provides clear explanations of what it does and why. One bad year, especially the past one, merits forgiveness, but a history of backsliding or high expenses is reason to make a change (for a yardstick, see our annual mutual fund rankings).
Diversify. One lesson we've learned is that U.S. stocks, bonds and cash are not a complete mix of investments. A long-term investment plan needs natural resources (water, oil and gas, agricultural products, and land), plus foreign bond or currency funds and some income-producing real estate securities. Those alternative categories should account for about 10% of your assets, or possibly 20% if you're adventurous. You can move into new areas gradually by dollar-cost averaging into mutual funds or exchange-traded funds, such as PowerShares DB Energy (DBE) and Market Vectors Agribusiness (MOO).
Avoid overlap. It's possible that four or five of your funds hold the same blue-chip stocks, such as Disney and McDonald's. If so, you don't need individual shares of those companies. But an ETF such as iShares Russell 2000 Index (IWM) holds small companies that you are unlikely to own. (The x-ray tool at Morningstar.com lets you check your portfolio for overlap.) Your foreign funds should have a presence in places other than Europe and Japan, so you may need to add an emerging-markets fund, such as T. Rowe Price Emerging Markets Stock (PRMSX), another member of the Kiplinger 25, to gain global exposure.
Dollar-Cost Averaging: How (and Why) It Works |
Use this sane strategy to rebuild your stock holdings. Mutual funds are particularly well suited to this type of regular investing.
Set up a schedule. Decide how much money to invest each month or quarter. You can plan on increasing the amount as your income rises.
Arrange automatic contributions. Pick a mutual fund (or several) and arrange for a direct transfer of a fixed dollar amount from your bank account.
Reap the rewards. Because the transfers are automatic, you're protected from letting your emotions or the latest news lead to mistimed purchases and sales. Plus, you buy more shares when the price is lower and fewer shares when prices are high.