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Taking Charge in a Downturn

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar. After the last few days in the market, investors can't be blamed for getting that oh-no-here-we-go-again feeling, but what should we make of the recent market volatility, and what does it mean for our portfolios?

Here with me to offer some insight is Morningstar's Jeremy Glaser, he's the markets editor for Morningstar.com, and Christine Benz, she's director of personal finance. Thanks for joining me, guys.

Christine Benz: Jason, nice to be here.

Jeremy Glaser: You're welcome, Jason.

Stipp: Christine, you and I have talked about portfolio allocation for a lot of different reasons, and in a lot of different contexts before, and I have to say that I've never heard you recommend selling everything in your portfolio and moving into cash and Treasuries.

Benz: That's not something I would say, is it, But it's something investors have been feeling inclined to do recently. I would say that the recent market volatility is a good wake-up call if you have money that you can't afford to lose. Maybe it's the property tax money, or next year's tuition bill, or if you're retired, your living expenses.

You need to have that money in relatively safe investments. It shouldn't be in stocks. So have that as something that you have in the back of your mind when you're thinking about this volatility. That you do need that cash sleeve carved out.

Stipp: Certainly it's good not to let the market dictate all of your decisions, but it's going to be hard to ignore the market. The market is everywhere. It's on your mobile device, it's on cable channels, it's in the newspaper. How should I think, if at all, about what kind market movements we've been having? How should I think about my portfolio in that context, and should I make any moves based on them?

Benz: Well, normally I would say no, but when you do see the kind of market move we've seen recently, with stocks moving down so appreciably, it might be time to look at re-balancing. Some people re-balance on an annual basis, or on a calendar-year basis. That's fine. Stick with that, if that's what you're doing.

But if you're someone who re-balances when you see your asset allocations veer significantly from your targets, maybe it's time to get in there, use our X-ray tool to see where you are, in terms of your allocations, and maybe think about bumping up your stock position. One thing you might do is consider doing it over a period of a few months, rather than doing it all in one go.

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Stipp: So if you're feeling nervous still about the market, but you do maybe want to re-balance a little bit, just over time, dollar cost to average, and then if it goes down some more, you can get some cheaper shares.

Benz: Exactly.

Stipp: So, Jeremy, on a day like Thursday, when we looked across the market, nearly everything was going down. When I'm looking at my portfolio, and say maybe I have some stocks in my portfolio, how can I tell what's going down for a good reason because maybe the fundamentals have changed, and what's sort of baby-with-the-bath-water, and it's just a good quality company that's just getting hit?

Glaser: I think you're right. There certainly have been fundamental reason that stocks have been selling off over the last couple of weeks. Worries about European growth are more than just about debt. They're actually about their economy is growing very, very slowly, and what's the impact of that on China? What's the impact of that on the United States?

So, I think companies that have a lot of exposure to Europe, you're seeing them sell off. I think that some of that probably is correct. Some of that probably means that expectations for future growth are lower, but certainly there's many companies that are very high quality that are going to be impacted somewhat by that, but it's not going to be a major driver of their business.

I think it's those high-quality stocks that you need to focus on in your portfolio. So if you're holding, say something like Microsoft, or another company that has big competitive advantages, that's the sort of name that you're going to not sell when you see these worries in the market.

If you did want to, let's say, reduce your allocations to stocks, if you look at your asset allocation and you have too much in equities, you want to look at those lower-quality names, the ones without the competitive advantages.

But it's also important to note that just because a company is high quality, doesn't mean that it's not going to have volatility. I think we're going to see a decent amount of volatility. We've seen it over the last couple of weeks, and I think we're going to continue to see it. There's a lot of question marks in the world economy, and stocks are going to move up and down based on the answers to those questions.

It's important to have that long-term time horizon, so that you can ride that volatility out. In stocks, you're getting paid have that volatility. The reason you're getting a premium over, say bonds or other safer investment, is because of that risk that you're taking on.

So, the high-quality names certainly mitigate the risk of permanent capital impairment, but certainly there's going to be bumps down the road, and it's something investors should be aware of, and definitely plan for.

Stipp: Sure. Now Christine, looking at a portfolio over time, I think that we probably can't say that if you're really risk averse, you should not be in stocks at all. For a lot of people, including retirees, they probably need to have some portion of their portfolio in stocks because this could be a 30-year prospect, retirement. Given that I probably need them in my portfolio, how can I figure out a way to hold them, and not be up all night worrying about this volatility.

Benz: Well, some people might call it mental accounting, but this bucketing approach has really taken off, in part, because it does make intuitive sense at times like this. So if you have your portfolio split into two sleeves--one is your safe stuff to cover your near-term expenses, and the other the growth portion, the growth engine, primarily stocks--you can afford to not worry too much about that stock position, if you have that cash and short-term bond allocation carved out of your portfolio.

So I think that that's a good starting point for retirees, because you're right, they do need stocks, they need that growth potential.

Another thing, I would very much echo Jeremy's comments. Quality is a good place to be, particularly for retirees, no matter what the market environment. So I would point to a couple of high-quality funds that I like. A good old S&P 500 index fund will get you a lot of high-quality names, wide-moat names. Also, Dreyfus Appreciation is another one I like, and also Jensen Portfolio, which I know is one of Morningstar.com user favorites. Very "moaty" portfolio there.

Stipp: Jeremy, if I was going to look for high quality among stocks, where might I start, if I did want to put some money to work here, and upgrade my portfolio?

Glaser: There's a couple of really great wide-moat stocks that are starting to look a little cheap. Names like Johnson & Johnson, ExxonMobil, Paychex. These are businesses that are going to be able to overcome almost any difficulty in the world markets, and that are looking pretty attractively priced right now.

Stipp: Christine, Jeremy, thanks so much for joining me for your insights.

Glaser: You're welcome, Jason.

Benz: Thanks, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.