Surviving Market Mayhem

By Dan Kadlec

If you want a friend, buy a dog. Those words are most often attributed to the corporate raider Carl Icahn in the mid-1980s and were later immortalized by the character Gordon Gekko in the film Wall Street. But given today's hostile environment for even conservative investments like munis and mortgages, you too may be muttering the phrase--right now.

If so, you're in high-profile company. The brokerage Bear Stearns wound up dogless a few weeks ago. Bear Stearns, known for extreme self-interest, couldn't find a friend to throw it a lifeline. Now it's as good as gone.

Your nest egg doesn't have to suffer a similar fate. Any time turmoil strikes the market and your notional allies--in this case, banks and bond-rating agencies and bond insurers that are supposed to backstop you--fail in their duty and leave you, well, dogless, it's a good time to take a good look at what you own. In this sense, says Guy Cumbie, a financial planner in Fort Worth, Texas, "anything that stress-tests your portfolio and gets you to pay attention to the level of risk you are taking is a good thing."

You may already be so well diversified that you need not make many adjustments. A disciplined investment approach through good times and bad is ever the best policy. Trying to time the stock market is especially futile. In the 20 years through 2006, the Standard & Poor's 500 returned an average annual 11.8%, but the typical stock-fund investor earned only 4.3%, according to a study by research firm Dalbar. Fund fees play a role in that gap. But investors' errant attempts to move in and out of stocks at lows and highs are mostly to blame.

What should you do? Rebalance, for starters. Any exposure you have to gold, oil and other commodities may have grown too large. Ditto for emerging markets and small-cap stocks. But big-cap U.S. stocks (especially in health care and consumer staples) may have shriveled too far. Real estate may have shrunk as a part of your portfolio too, but because most investors are homeowners, they already have a stake in that game. By all means, stick to your dollar-cost-averaging regimen, whereby market volatility actually boosts returns because you automatically buy while prices are down.

Even a disciplined approach, though, allows wiggle room to get more or less aggressive. Right now it pays to play things safe, says Richard Bernstein, chief investment strategist at Merrill Lynch: "There is nothing wrong with cash." Yet be warned: yields on money-market funds and bank CDs are low and going lower. Don't plan on holding lots of cash for more than six months. One good option, says Bernstein, is Treasury bonds, which on a total-return basis have outperformed stocks in five of the past eight years--a first since the Depression. He believes that trend will hold this year. Bernstein also likes stocks of large-cap companies and, as a play on the weak dollar, foreign stocks that pay a dividend (in euros or yen). Consider MFS International Diversification, which recently had a 12-month yield of more than 5%, or Wisdom Tree International Dividend, an exchange-traded fund that recently had a net yield of 4.5%.

Investor Wilbur Ross called attention to the "relatively unparalleled" values in the muni-bond market in March, when he revealed a $1 billion position. Muni yields almost never beat Treasury yields because both are considered safe, but the income from munis is tax exempt. That anomaly occurred earlier this year, and even though some order has been restored, muni yields remain historically high. "These aren't as safe as cash," says Mark Soehn, managing director at Financial Solutions Advisory Group in Chicago. "But the risk is well worth it." He recently put his clients into the BlackRock International Municipal closed-end fund, which was trading at an unusually large 12% discount to the assets in the fund and yielding 5.7%. The after-tax equivalent of that yield for someone in the 30% tax bracket: 8.2%. Steep discounts and generous yields are still available in closed-end muni funds, including DTF Tax Free (recently at a 10% discount, with a 4.4% dividend).

No matter how much it looks like the end of the world, the end never really comes. Those who stick to a plan and grab bargains when others leave them behind reap the best long-term rewards--whether their friends are with them or not.