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Four Ways to Prepare for the Rebound

Things do look dire, but it's possible that the world might not end tomorrow.

Gregg Wolper, 03/17/2009

It's hard to think about the good times to come when the stock market is getting pounded day after day. But a savvy investor knows that overestimating the permanence of today's conditions is a dangerous habit. Such reminders typically come when markets are climbing, but the concept is equally important when the atmosphere is dismal.

At some point, the stock market will stage a steady recovery. That could be a long way away; it might arrive sooner than anyone thinks. But a nice, sustained rally is almost certain to come along. That's not just my opinion--you agree! At least those of you who have more than a pittance invested in stocks or stock funds--if you didn't agree, you wouldn't own them, right?

With that in mind, it makes sense to prepare your portfolio accordingly. For a variety of reasons, there's a good chance that your current positioning isn't where you'd want it to be if (I mean, when) the market recovers. Maybe your allocations got out of whack because stocks collapsed; perhaps you've sold holdings to take tax losses and haven't replaced them; maybe you were lucky enough to own stock in Wal-Mart WMT and its stellar performance during the crash has made its weight in your portfolio much, much larger than it used to be.

You don't necessarily have to return your portfolio to its precrash allocations or own the same funds that you did then. Nor do you have to jump in immediately: Encouraging mindless optimism is not the aim here. Rather, the point is this: At a time when our personal investments are the last things that we want to think about, it's critical to force yourself to look them over. Think about what you want your overall portfolio to look like for the long term and remember that that long term will probably include a recovery in the stock market. Then see how closely your current holdings resemble the framework you have in mind.

The Stock Market? Are You Crazy?
The values of all types of stocks have fallen so far, in comparison to cash and most bond funds, that even investors who simply stood pat no longer have the allocations that they once did. Late last week, the S&P 500 Index was down nearly 60% from its October 2007 high. By contrast, cash isn't down at all, and unless you owned the most disastrous bond funds, they held up much better than your stock funds.

As a result, your portfolio probably has a much lower allocation to stocks than it did before the crash. So, take a deep breath and decide if you still want the same allocation to stocks as you used to have. If not, fine--pick a new number. That will take a bit of thought and effort, but the opposite approach--simply closing your eyes and hoping that things will work out--isn't a reasonable option, tempting as it may be.PAGEBREAK

A Cash Stash, or Not
A Fund Spy column that appeared on Morningstar.com this February noted that many of the top-performing funds during the downturn held fairly substantial cash stakes, and the article asked whether investors would prefer that their portfolio managers were able (and willing) to hold cash at times. A follow-up provided your answers. Many of you indicated that you do want managers to have the flexibility to shift assets out of stocks--perhaps holding huge amounts of cash--if they can't find enough stocks to suit them or if they expect a broad market downturn.

Now's the time to make sure that your funds have the policies you want. When the market rebounds, funds with cash are quite likely to lag. You have to be comfortable with that being the trade-off for protection during declines. If your fund companies' documents don't provide clear explanations of their policies in that regard, call them up and ask specifically how much cash the manager is allowed to own and what the levels have typically been over time. (In many cases the formal limit listed in the prospectus might be fairly high but, in practice, the fund almost always remains almost fully invested.)

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