We try to follow advice that's supposed to be good for us. Parents tell children to eat their vegetables. So the children do. Wall Street tells adults...
We try to follow advice that’s supposed to be good for us.
Parents tell children to eat their vegetables. So the children do.
Wall Street tells adults to be long-term investors — to “buy and hold” stocks and mutual funds for the long term. So investors try. But many investors think they are doing what they’ve been told to do and end up getting the buy-and-hold lesson terribly wrong.
They buy stocks and mutual funds willy nilly, based on a hot tip, TV chatter, a suggestion from a co-worker or a glowing article, and then, later, they wonder what happened to the glow. They pick mutual funds with confusing names in 401(k) plans, and have no idea why they are making money one day and losing it the next. They buy a stock with great prospects at one point and then months or years later can’t say why they think it’s a fine investment. Or they inherit a stock from Grandma and tuck it away the same way they did her china.
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Because many Americans make these mistakes when “buying” investments, they get the “holding” part of the slogan wrong, too.
Buy and hold doesn’t mean to buy and hold anything. It means to carefully assemble a mixture of stocks and bonds, and then stick with the mixture whether the stock market is good or bad, something the stock market has been both in recent weeks. That system — which is called “diversifying” or “asset allocation” — tends to work well over time because something in your investment portfolio is usually climbing, even if something else is being battered.
But if you buy stocks on an impulse, you better know when to get out, or you could lose everything you put into it. Companies, after all, go bankrupt and others take investors by surprise with major business missteps and drop sharply in a short period of time.
The buy-and-hold message needs particular attention now as worries build about a possible recession. Experts generally tell investors they don’t need to flee the stock market.
But when investors hear that, they should not misconstrue the buy-and-hold advice. It’s based on the assumption that you have invested with care, building a lot of insulation into your 401(k) or individual retirement account so that if a stock or fund drops sharply, another investment will buffer the plunge and keep you from losing too much.
If you haven’t provided yourself insulation, you may end up like investors did in 2000 to 2002. They had bought mutual funds filled with technology stocks, assuming they were a safe bet because the funds had soared in previous years. Then, as the stock market sank, these well-intentioned people obeyed the buy-and-hold message, held onto the plunging technology mutual funds and lost 80 percent of their money. Roughly five years later, an original investment of $10,000 would have been worth only about $5,000.
To provide insulation against downturns, investment adviser Jim Mosteller said he would divide a portfolio for an investor within 20 years of retirement roughly like this: 32 percent in large-cap funds that invest in the nation’s largest companies, 16 percent in small-cap funds that invest in small company stocks, 16 percent in international funds that invest in developed markets such as Western Europe and Japan, 8 percent in emerging markets (areas including Brazil, Thailand and Pakistan), 8 percent in real-estate investment trusts and 20 percent in bonds.
And Mosteller, based in Willowbrook, Ill., says he would try to convince investors that they take on extraordinary risk if they rely on a single stock, or a small handful, instead of mutual funds.
He ran into this with an individual with 80 percent of his IRA in Walgreen stock. A rule of thumb in investing is to hold no more than 5 percent of your total investment portfolio in a single stock. Yet, Mosteller’s client, like most people holding a stock that had done well, protested that it was “a fine company.”
“Think of Enron, United or General Motors,” he said. “They were all good companies.” But Enron collapsed, United’s parent went into Chapter 11 and GM has struggled.
Analysts have warned investors to be cautious about investing in certain sectors that are likely to feel the brunt of an economic slowdown. The obvious examples are financial stocks, homebuilders and companies — such as retailers — that sell to consumers. The sectors already have taken a big hit.
But Merrill Lynch economist David Rosenberg has noted that operating earnings at a wide range of companies are slowing. And when that happens stocks tend not to climb, and will fall if profits drop significantly.
Although analysts generally suggest that certain sectors — such as health care and consumer staples — are safer in downturns, nothing is spared in a serious bear market, or a decline of 20 percent or more.
Analysis by Ned Davis Research shows that some of the most popular industries of the past few years could be hard-hit in a bear market.
Between 1973 and 2002, the average decline of commodity stocks during bear markets has been 27 percent, while industrial companies dropped 28 percent. The worst declines are 33 percent in information technology and 31 percent in consumer stocks.
The safest four are energy, with a decline of 12 percent; utilities, which lost 13 percent; consumer staples (which make products such as soap and toothpaste), down 17 percent; and health care, off 18 percent.
Generally in stock-market downturns, the industry groups that gave investors the highest returns over the previous few years suffer the most.
Ned Davis analyst Lance Stonecypher said that if it holds true in the current downturn, energy, materials and commodities would face the highest risk.