Financially Sound: Preserve And Protect

Smart strategies for investing in a challenging market

by Lisa R. Boone, Certified Financial Planner™, Vice President — Wealth Management, Smith Barney

June 1, 2008

W hether you get your news from the newspapers, television or Internet, you know how quickly the financial markets can change. Some days are euphoric (a key economic report may bolster consumer confidence or a company's better-than-expected quarterly earnings report can ignite market indexes). Other days, however, aren't as sunny – and some of them may be downright unnerving. 
    
So what are some of the possibilities when an inevitable downturn occurs in the market?     

An important piece of advice to keep in mind during a market slide is one you've no doubt heard before: Do not overact. Even though your instincts may be telling you to try to protect your investments by switching to a more conservative approach or to liquidate your positions altogether in hopes of buying them back at lower prices when the worst is over (timing the market), it's important to keep your emotions in check – and your eyes on the long-term horizon.   

History tells us that over the long run the stock market can be quite resilient. From wars to natural disasters to economic meltdowns, the market has seen it all – and over time has shown remarkable capacity to bounce back.     

While it's not always easy to maintain long-term perspective, overreacting to events as they unfold may compound the damage – and you may end up selling at the bottom or missing part or all of a subsequent market recovery.     

To help protect against loss and the anxiety it may create, develop a diversified investment plan that reflects your long-term goals and tolerance for risk. If you stick to that plan in both good markets and bad, you are likely to experience less volatility and far fewer sleepless nights.      

Meanwhile, here are some investment strategies that – when carefully applied – could help better prepare you to respond to major economic and investment trends that may affect your portfolio's performance: 

Periodically fine-tune your portfolio's asset allocation
Watch the recommended asset allocations of the major wire houses to see tactical shifts in weighting between stocks, bonds and cash. Their economists and strategists are constantly monitoring the economic and political landscapes to best recommend to their clients how much of a total portfolio should be placed in each asset class. You won't generally see wholesale shifts, but rather small percentage changes.

Review individual stock positions     
All stocks are not created equal – some perform better in certain market environments than others. Learn what does well in a slowdown, such as consumer staples or "defensive" stocks. Then, position yourself with companies that are likely to charge out of recession with a faster than market recovery.      

And, watch the political landscape for potential changes to policy that might affect certain key industries. As a general rule, you don't want to expose yourself to the potential risk of one company or one industry dragging a large share of your portfolio down, so diversify your holdings. 

Take advantage of convertible securities     
Convertibles are corporate securities (usually preferred stocks or bonds) that may be exchanged for a specified number of another form (usually common shares) at a pre-stated price as defined by the corporation upon issuance. The most significant aspect of convertibles is that conversion takes place only upon the holder's request. So, when it is to your advantage to buy the stock at a lower price than the market, you activate the convertible feature.   

Rebalance your portfolio with fixed income opportunities     
Fixed incomes (bonds) generally move in opposite cycles to equities (stocks). This negative correlation means that when stocks are underperforming, bonds should be outperforming. So, when the stock market is in a declining pattern, adding bonds to your portfolio tends to act like a counterbalance. Best to buy high quality, AAA-rated bonds. For those in the highest tax bracket, municipal bonds offer tax-free income. They do fluctuate in value with prevailing interest rates and market conditions, so plan to hold them to maturity to mitigate the risk. 

Consider alternatives to cash     
Keep your cash reserve (three to six months operating expenses) in a money market account, which will earn you more than passbook savings rates. Alternatively, consider "laddering" your cash in three-month, six-month, nine-month and 12-month certificates of deposit. Anything more than six months reserve should be invested. A medium-term time horizon justifies purchasing a government or municipal bond, whereas a long-term goal can be invested in the stock market, generally surviving the ups and downs. 

Set investment horizons globally     
In order to protect and grow your assets, they must grow faster than inflation and taxes. Diversification outside of the U.S. may help achieve these goals by decreasing volatility. International investing may also increase returns as exposure to growing economies around the world may hold opportunities beyond what can be achieved domestically. Note there is a higher degree of risk and potential return when going into markets labeled as "emerging markets," rather than sticking with "developed countries."  Establish a regular investment program,  such as dollar cost averaging     

Trying to time the market is a fool's game because it is practically impossible to know when to buy or sell to take advantage of high or low stock prices. Instead, consider the time-tested strategy of dollar cost averaging into the market.      

Simply put, dollar cost averaging is a method of investing a fixed amount of money at set intervals. Choose a day of the month that every month you contribute to your investment account. Some times you will be buying at lower prices, other times higher. But at the end of the day, you will average out your cost basis and likely achieve the average historical rate of return.

Lisa Boone is a vice president for Smith Barney and a certified financial planner™.  She has focused her practice on helping women take charge of their financial futures goals.  She has been involved with Smith Barney's Young Investors Educational Program, Take Your Children to Work Day, and in mentoring young women through the firm's intern program. A graduate of the University of South Carolina, she is an avid runner, plays golf and is a long-time member of the world's oldest culinary society, Le Chaine des Rotisseurs.  Boone lives in Buckhead with her two teenage daughters, Lucy-Marie and Madeleine. She can be reached at lisa.r.boone@smithbarney.com.