Worst-case scenario puts hold/sell picture into focus


NEW YORK -- These are the times that try the souls of investors determined to buy and hold.

Intellectually, you know that buying stocks and holding them for the long term is the best way of building wealth. Emotionally, however, you twitch every time the stock market loses 50 points. You wonder if you should sell your stock-owning mutual funds -- and the bond funds, too -- and put the money in the bank. Plenty of experts are telling you to do just that.

The trouble is, you can never be sure of exactly when to sell or buy. The handful of mutual-fund managers who have stayed ahead of the stock market over long periods of time usually are fully invested. Their stellar records come from picking good stocks, not from trying to guess when the market will rise or fall. In bad markets, they take their lumps; in good markets they come roaring back, thanks to the many fine stocks they bought when prices dropped.

As an itchy amateur, however, how do you discipline yourself to hold onto your mutual-fund shares when the market drops? One answer is to know the worst and see whether it is likely to hurt your long-term financial plan.

To make this decision, here's the critical fact you need: If stocks decline by 15 percent or more (my definition of a bear market), how long will it take to recoup your loss?

I put that question to consultant Derek Sasveld of Ibbotson Associates in Chicago. He checked the record, using Standard & Poor's 500-stock index as a proxy for your mutual funds and assuming that you reinvest your dividends. Here's what he found:

There have been eight bear markets since the end of World War II. The average time it took for market values to drop and then return to their starting point was nearly 22 months. That's the full bear-market cycle.

The shortest cycle was 10 months, starting in May 1990. The longest was 43 months, starting in December 1972.

This suggests that as long as you won't touch your money for three to four years, it's safe to ignore a market drop. Put your retirement contributions into stock-owning mutual funds and leave them there. Keep adding to them every month. Buying fund shares at lower prices will improve your long-term returns.

But if you will want your money for a definite purpose within three years, sell your fund shares now and put that money into something safe -- a bank account, short-term Treasury securities, a money-market fund or Series EE Savings Bonds. If you can hold for at least six months, EE bonds pay a minimum of 4 percent.

What if you aren't reinvesting your dividends but are withdrawing them to live on? In that case, holding stocks presents more risk.

With no dividends to cushion the losses, the average bear-market cycle has lasted a bit more than 31 months. The longest one ran for 92 months, from December 1972 until July 1980. Over that many years, it's pretty hard to keep the faith.

But bond funds are worse for people who withdraw dividends. Bonds give you a better current income, because interest payments are higher than stock dividends. But in a bear market, your capital could lose value for years.

Cycles in bond prices last for decades. From a low point in 1932, prices rose to a peak in 1954, then declined until 1982, then rose again. Had you bought bond funds just prior to the '54 decline, and withdrawn all interest payments, it would have taken 39 years for your capital to equal what you started with (assuming the fund owned intermediate-term bonds). Had you bought in December 1976, it would have taken almost 10 years.

If you want pure interest income plus the security of getting your capital back within five to 10 years, it's safer to buy individual bonds. Unlike most bond funds, individual bonds have fixed dates when you will get your capital back.

On the other hand, if you reinvest all your dividends in bond mutual funds, you'll be OK if you buy and hold. Reinvestment greatly cuts back on any market losses. In fact, assuming that you bought just prior to each market drop of 5 percent or more, you'd have recouped your money in an average of 17 months. Your longest wait would have been 25 months.

So if your bond fund is down, keep reinvesting dividends and take heart.

Jane Bryant Quinn is a syndicated columnist. Write to her at: Newsweek, 444 Madison Ave., 18th Floor, New York, N.Y. 10022.

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