Time to rebuild your portfolio

As small investors thread their way through the rubble of the US stock market, signs of rebirth and reconstruction are starting to appear.

Stock prices of many companies, analysts say, are more in line with their earnings. "The market is becoming fairly valued," says Richard DeKaser, senior vice president and chief economist with financial firm National City Corporation in Cleveland, adding that it may be time to start buying some selective issues.

The interest-rate easing by the Federal Reserve is now "beginning to work its way through the economic system," Mr. DeKaser maintains. A rush to refinance mortgages at lower interest rates is freeing up additional cash for consumer purchases or investments, he notes. And finally, "the huge inventory correction of the past few months" - that is, the buildup of merchandise on display floors and in stock rooms - is starting to abate, which frees up debt loads and expenses for scores of US businesses.

The recovery will be "more muted" than he had thought likely some time back, says DeKaser, but it still should be enough to prevent a recession. And enough to start a market upswing.

At the very least, the US economy should resume growth by the fourth quarter of 2001, says David Wyss, chief economist with Standard & Poor's Corp. in New York. Mr. Wyss believes that a tax cut - which he now sees as likely - should help boost economic growth. Some analysts differ. A report last week from the respected Anderson School at the University of California, Los Angeles, cited a 90 percent likelihood of recession this year, although it expects it would be short-lived.

Most investors, battered by recent market volatility, will happily accept any glimmers of good news at this juncture. For smaller investors, after all, the overarching issues, as the market headed southward during the past year, have been twofold:

1. How to protect existing financial assets, especially those linked to the stock market.

2. How to ensure that assets are well-positioned to take advantage of the eventual shoring up within the market.

Banking on an (eventual) upswing

Having a reconstruction plan is clearly necessary, given the sharp losses of the first quarter of 2001, which ended March 31. As the accompanying tables show, virtually all major mutual-fund sectors took a nasty drubbing.

Science and technology funds led the downward parade, followed by health and biotechnology issues, according to Lipper, Inc. But virtually all other types of mutual funds were also clobbered, especially anything with the word "growth" in it.

A rebound for value

The only bright spot among equities were small-cap value stocks, which eked out a minuscule gain. And real estate investment trusts, REIT funds, held their losses to under 2 percent.

The average diversified US equity fund lost about 13 percent for the quarter.

Diversification in international funds didn't help much. They too were down. To really have posted gains during the quarter, an investor had to be in "bear-market" funds - funds that employ exotic hedging strategies, including techniques to "short the market" - that is, to profit from downward gyrations.

Or, they had to own bond funds. Fixed-income investors may have seemed stodgy when the Dow Jones Industrial Average and Nasdaq Composite Index were sailing into new highs. But in hindsight, bond investors look like geniuses.

Bear funds, for their part, tend to be sophisticated and expensive, usually requiring outlays of between $10,000 and $25,000. Rydex, for example (800-820-0888) requires a minimum total investment with the company of $25,000, although you can buy into a single fund for as little as $1,000, according to a spokeswoman. ProFunds (888-776-3637) requires $15,000 for its no-load accounts, and $5,000 for load accounts through a financial adviser. You may, however, be able to find funds with lower minimums through discount services such as Charles Schwab & Co.

Most small investors tend to avoid the complexity of bear funds and stay with more-traditional funds. In that case, it is necessary to ensure that your original investment plan is up-to-date and still relevant, says Michelle Smith, who heads up the Mutual Fund Education Alliance, in Kansas City, Mo.

Long-term investors, Ms. Smith says, will most likely need to do little if any recalibrating of their original plan. The plan, she says, should be based on long-terms goals, such as retirement and college education for children.

Such investors, she says, still need to gun for growth over mere safety, which means buying stock funds more than bond funds.

But investors at or near retirement may need to add some safety by buying bond funds or shifting some assets to money-market funds.

Experienced investors also know funds that hold stocks paying dividends tend to hold up better than the average fund with nondividend-paying stocks. Dividends provide a modicum of defense against market declines.

Factor in your time until retirement

Time is perhaps your most important consideration, says DeKaser. "If you are investing for at least 10 years or more, the current downturn should not really affect your overall investment plan," he says. "Long-term investors need to wait out the correction.

"You certainly don't want to exit stocks that you bought based on their underlying fundamentals just because they have fallen in value," DeKaser adds. If you do, you will ensure an immediate loss. And you will forgo the opportunity of future price appreciation, as the market rebounds, he says.

An investor looking at the market today "really has two main choices," says Larry Wachtel, a vice president of Prudential Securities Inc., in New York. "You can assume that after close to $5 trillion of market losses, we are either approaching the bottom, or are there, and it is time to start putting money back into the market. Or you can do nothing until we know that we have definitely landed at the market bottom."

But by waiting, you may find that you are actually incurring costs through lost opportunities. Besides, he says, what happens to the thousands of individual companies that make up the total US stock market is not determined by what happens to indexes. The Dow, for example, is based in 30 companies.

Most financial planners recommend that when you do reenter the market, you should do so through dollar-cost averaging - committing small amounts of money on a monthly or quarterly basis. Thus, if there were to be additional market declines, your losses would be evened out.

(c) Copyright 2001. The Christian Science Monitor