Rebuilding Your Wealth: Investments

“Be greedy when others are fearful” is Warren Buffett’s oft-repeated advice. Of course, it’s easier to muster the courage to buy stocks when you’ve got Buffett’s billions as a cushion. Still, history shows the best way to rebuild portfolios is to stay in the stock market—which means that forward-looking investors are already thinking about rebalancing and diversifying their portfolios, despite the market’s terrifying tumbles. “This is likely to be one of the best buying opportunities, if not in the last decade, then in the last century,” says financial planner Harold Evensky.

Economists think the U.S. is already in a recession—and that’s good news for stock investors, since stocks tend to rebound before the economy does. Over the past nine recessions, the S&P 500 has gained an average 13 percent during the second half of the downturns and another 13 percent the year after they ended. Even during the Great Depression, the S&P rose 33 percent from the market’s trough to the end of the recession. And while it’s folly to try to predict a bottom, with the market down 40 percent from its 2007 high, it may not be far away.

Which isn’t to say that it’s time to throw caution to the wind. It’s worth keeping a portion of portfolios in cash and bonds for emergencies, peace of mind and bargain hunting. Planners like Evensky are keeping many clients at least 15 percent in cash, more than they might in a calmer market—and investors on the cusp of retirement should have a much higher proportion in cash and bonds. Although inflation concerns have subsided, economists expect them to reemerge in a year or two as the economy digests the costs of the credit crisis. One way to prepare is by buying Treasury Inflation-Protected Securities (TIPS) and limiting bond exposure for now to shorter-term, high-quality issues. 

But the stock market remains the place where portfolios will get a rebirth. The best news may be that U.S. stocks are garage-sale cheap; right now the average stock in the S&P 500 sells for less than seven times its cash flow, a low not seen in at least a decade. Still, stocks could continue their roller-coaster ride for a while. “Now’s not the time to be a hero” and load up on risky names, says Al Frank fund manager John Buckingham. Instead, strategists favor cash-rich blue chips in defensive sectors, such as consumer staples and health care, that can weather the slowdown better than other companies, as well as technology giants, whose profits have been relatively resilient so far. And with the market expected to return 5 to 8 percent a year over the next decade—well below the returns taken for granted in the past—dividends matter even more. The best way to buy is “dollar-cost averaging”—committing to purchases at regular intervals so that you reduce the impact of short-term price swings.

The losses in some foreign markets make the S&P 500’s losses look positively tame. But once the dust settles, exposure abroad will be crucial to rebuilding wealth. Veteran global managers like IVA’s Charles de Vaulx see opportunities in more-developed foreign markets, including Japan, where some blue-chip companies pay dividends of up to 5 percent, and parts of Europe outside of England and Spain. And recent deep sell-offs mean emerging markets like China and Brazil are “like a high-end boutique with a half-off sale,” says Rob Arnott, chairman of money-management firm Research Associates.