27 April 2007
By Tami Luhby
Now you know why investing in the stock market is like riding a roller coaster.
Less than two months ago, some investors were panicking because the Dow Jones industrial average plunged 416 points in one day, falling to 12,216.24.
This week, they are celebrating because the Dow hit an all-time high, surpassing 13,000. Yesterday, it closed at 13,105.50, up 15.61.
So what's an investor to do?
Nothing, experts say.
"There was no reason to change before and there's no reason to change now," said Ray Mignone, president of the Long Island Financial Planners Association, who practices in Little Neck. "Don't try to be smart and figure out when to go in and when to go out."
The recent market gyrations show why investors shouldn't take drastic steps when stocks suddenly soar or plunge. Those who ran scared in February sold at a low point, while those who jump in now may be buying high, experts said.
Instead, investment advisers say, you should maintain a well-balanced portfolio designed to reach your investment objectives. To do this, you should determine your goal and then figure out what savings rate and asset allocation will allow you to achieve that goal. In general, younger people should invest more heavily in stocks because they provide the greatest return in the long run and younger folks have the time to ride out the volatility. Those nearing retirement, meanwhile, need a more stable portfolio. So they should load up on bonds, which don't fluctuate as much, but maintain a healthy share of stocks so the returns outpace inflation.
Remember that the 30 stocks in the Dow Jones represent only about one-quarter of the total funds invested in the U.S. stock market, said Michele Gambera, chief economist at Ibbotson Associates, a subsidiary of Morningstar. It is not an investment strategy, but a gauge for the overall market.
The S&P 500, meanwhile, is more representative of the market as a whole, he said, accounting for about 80 percent of the total capitalization. That index is also nearing its high of 1,527.46, closing yesterday at 1,494.25.
Regardless of the market swings, investors need to keep the bigger picture in mind, said Erika Safran, a principal at Financial Asset Management in Manhattan. And usually they should act the opposite way that they feel - buying when the market plummets instead of selling.
"The best time to invest is when it hurts the most," she said. "February would have been a great time to invest."
This is not to say that investors should create an asset allocation and then walk away for 40 years. They need to revisit their holdings on occasion to make sure they are still on track. Often, this may entail paring back on stocks or funds that have done well and adding to sectors that have underperformed. Safran recommends rebalancing twice a year.
Allocation is the key
How much you hold in stocks and bonds depends on your age and risk tolerance. Here is a portfolio breakdown by age for investors with average risk tolerance.
25-year-old
The younger you are, the more heavily you should invest in stocks. Stocks offer the highest returns and younger investors have the most time to ride out the market's ups and downs.
U.S. bonds 15%
U.S. large-cap stocks 40%
U.S. small-cap stocks 16%
International bonds 5%
International stocks 24%
45-year-old
As retirement gets closer, but still at least 15 years away, adjust your strategy to a more conservative mix. That means fewer stocks and more bonds.
U.S. bonds 30%
U.S. large-cap stocks 34%
U.S. small-cap stocks 12%
International bonds 10%
International stocks 14%
65-year-old
Investors approaching retirement need a more stable portfolio and should invest more in bonds. However, equities are still needed to make sure returns stay ahead of inflation.
U.S. bonds 40%
U.S. large-cap stocks 24%
U.S. small-cap stocks 9%
International bonds 10%
International stocks 7%
Market-neutral investments 10%
SOURCE: RAY MIGNONE, CERTIFIED FINANCIAL PLANNER
1,000 to 13,000 ...in 35 years
While it took the Dow Jones Industrial Average 76 years to break 1,000 in 1972, over the next 35 years it climbed more than 12,000 points
Crosses 8 milestones in 5 years
After 7-year wait, breaks 12,000 and 13,000
First trading day after Sept. 11, 2001 -685
SOURCE: Yahoo! Finance Dow Jones Indexes
How it's grown
A $1,000 investment in another index, the Standard & Poors 500, 20 years ago was worth more than $9,000 at the end of 2006. Note: Data assume total dividend reinvestment and separate payment of taxes.
1/1/1987 $1,000
12/31/1996 $4,184.60
12/31/2006 $9,312.36
SOURCE: MORINGSTAR