When the stock market goes through a crisis in confidence, so do ordinary investors. It's hard to have much faith in a financial plan when all of the news is bad.
The standard advice is "Hang on, for dear life," which is the hardest advice to follow at a time when your investment mettle is being tested.
While trading in and out of funds is frequently a recipe for disaster, there are moves that investors can make to improve their confidence and portfolio without blowing up the long-term returns that they supposedly surrender by giving up on a fund.
To see why that is, consider that the standard advice warns against riding trends or timing the market, because it is hard to use those strategies to improve returns consistently over the long haul.
The evidence supporting the idea that investors are supposed to stay put in funds during downturns is a long-running study from Dalbar Financial Services, which shows that the Standard & Poor's 500 had an annualized average gain of 11.8 percent over the past two decades, but the typical equity fund investor was able to capture just 4.3 percent annually.
But if you talk to the people who study behavioral finance -- the way investors act -- they are not opposed to small moves to boost confidence. They will warn of the dangers of portfolio overhauls, where an investor claims to be making faith-inspiring moves, but is really just tilting a portfolio in the direction of what has been hot lately.
The changes to consider in times like these are more about upgrading a portfolio than overhauling it.
Richard Geist, president of the Institute on the Psychology of Investing, said in a recent radio interview that investors should use nervous times as an opportunity to build their ideal portfolio, to make the list of stocks or funds they would want to buy if they could get a reasonable price.
They then want to compare that dream portfolio to what they have today, consider dumping any investments they would not buy again today and see if they can improve their holdings on the cheap.
That is great for stock investors, who can look at companies they would want to hold for a lifetime, see if a beating in stock price reflects any substantial change in the intrinsic value of the business and decide if they are getting a bargain.
It's a lot tougher in mutual funds, where each security represents an entire portfolio of securities, and a price beat-down holds no real clue as to whether you are buying assets on the cheap.
One thing the recent bearish conditions have brought out, however, is a lot of funds with great long-term track records are reopening to new investors.
Dodge & Cox Stock (DODGX), Dodge & Cox Balanced (DODBX), Royce Opportunity (RYPNX), Longleaf Partners (LLPFX), First Eagle Global (SGENX), Third Avenue International Value (TAVIX), Tweedy Browne Global Value (TBGVX), Wasatch Core Growth (WGROX) and Small Cap Growth (WAAEX) are some of the best names on a long list of funds that have started taking new cash from investors.
Those are the kinds of names that might have come up during an investor's research, the kind of names that have delivered solid and consistent long-term performance, but that were not available during better times.
Today, they are available for an upgrade.
"If you can build a better portfolio today -- if you're not happy with a fund you own and can now buy something you believe is better -- you'd be foolish not to try," says Leonard Goodall, editor of the No-Load Fund Portfolios newsletter.
"You need to worry about taxes, and about sticking with your asset allocation plan, but if you could look at your portfolio tomorrow and say, 'This is better than what I have today,' that's certainly good for you."
Even Lou Harvey, president of Dalbar, acknowledges that investors may be able to make a change without becoming the statistic -- the investor who gets that lousy return because he or she made a jump.
What the Dalbar study -- and the latest annual results are due out in a few weeks -- fails to account for is where the investor put his money next. An investor may bail out of a fund at the "wrong time" -- defined as just before the fund takes off -- but that makes it the "right time" to buy the better fund in the same asset class, capturing the rising tide that lifts the entire category.
"It's OK to switch from a fund that you think has lower prospects of return to one with higher prospects of return," says Harvey, "but what you are really betting on is the rate of recovery. You are saying, 'Here are funds in the same category; which one do I think will recover the best and fastest from this downturn?'
"You're keeping your asset allocation -- which is the key to getting the long-term performance you expect -- but in funds that give you more confidence than the ones you own today."
Charles Jaffe is senior columnist for MarketWatch. His postal address is Box 70, Cohasset, MA 02025-0070.