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Getting Back Into the Stock Market After Suffering Severe Portfolio Losses


The following case study offers suggestions for those who have sold off a lot of their stock holdings amidst the stock market meltdown.

Emily Davidson is confronting a double whammy, and has sought the counsel of a financial advisor to help her devise a plan to recoup the tremendous losses she has sustained in her investment accounts. Here's what happened. Emily got caught up in the bull market and had almost all of her money in stocks. At the urging of a friend who was using an investment advisor with a hot hand, she also used margin to leverage here stock portfolio. But two years into making easy money in stocks, the market slumped. She asked her friend what her investment advisor was recommending. The response:  "Hang in there, the market is poised for a rebound."  Well, stocks continued to decline and in a state of near panic after losing over half of her money, she sold all of her stocks. "I guess it could be worse," Emily noted. "My friend has lost two-thirds, but is still being encouraged to "hang in."  But Emily's problem now is deciding what to do now with almost all of her money sitting in money market funds. She needs a plan to avoid the classic double whammy:  abandoning stocks after a steep decline and missing the rebound.

Many investors overreact to market conditions and while this may bring some short-term peace-of-mind, unless changes are made, the longer-term effect may be deleterious. Investors need to balance their fears against achieving a portfolio that meets their long-term needs. Often, this involves a process of gradually moving the money to a more-balanced allocation. While this example focuses on an investor who has abandoned higher-risk securities, the approach also can be applied to those who my have too much of their money invested in stocks.

1. Investment objectives. Emily Davidson has moved from an all-stock portfolio to an all-cash portfolio. She realizes that neither extreme will achieve her investment objectives, so she needs a plan to attain a more diversified portfolio. The problem is that the stock market continues to decline and the economic outlook isn't favorable to stocks.

2. Timetable to redeploy the investment portfolio. Emily's advisor realizes that she is still frightened about losing more money, so she recommends a plan to begin very gradually getting back into the stock market. The advisor also recommends a similar approach to bonds, since interest rates on cash are very low. The strategy is to add one to two percent per month to stock funds and two to three percent to bond funds.  The following table shows the results of this strategy after one and two years. Emily is comforted by this approach. "I like this plan because I'm not making a big move all at once, but after a couple of years I'll be where I should be. If the stock market continues to decline, I won't have too much money in stocks. On the other hand, once the stock market starts to rise again, I'll have at least a bit of money in stocks. Finally, this plan isn't cast in concrete. I can always make adjustments like adding a higher percentage to stocks if conditions are improving. But my days of speculating and making big stock market bets are over."           





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This site was updated as of January 29, 2009

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