Keep Your Balance and Keep Your Head

03/10/2009 9:48 am EST

Focus: MARKETS

Janet Brown

Editor, NoLoad Fund*X

Janet Brown, editor of NoLoad Fund*X, says stocks are looking much cheaper, but she cautions investors to keep a balanced portfolio.

So far this year, stocks have had their worst start ever, exceeding the two-month losses of 1933. But then, another year when a new president took office during a financial crisis, markets soon turned up and nearly doubled over the next 12 months.

Now, after 17 months of extreme declines, global stock market prices have returned to where they were ten years ago, yet global GDP and earnings are about double where they were.

It's possible that the market is already in the bottoming process, with indices closing at their lowest levels in 12 years. The Nasdaq Composite index may have bottomed last November.

At the World Money Show in Orlando last month, many timers said they'd get back in when the Standard & Poor's 500 index reached 1100. For long-term investors, even if the market's next move was down to 600, and it took three years to reach 1100, it makes no sense to sell something for 700 and buy it back for 1100.

If you believe that the market will never recover, you should sell. That requires a complete loss of faith, not just in the stock market, but in the productive capacity of business. We still believe in the power of businesses, and their shares, to outperform all other investment classes over the long term.

Even after the recent terrible declines, stocks have outperformed every other investment category since records have been kept. This includes the Great Depression, when they lost nearly 90% of their value, as well as the current 50% decline.

Currently, the expected return on stocks versus 10-year Treasuries (the equity risk premium) is at an all-time high. After past periods of high equity risk premiums, stocks have outperformed bonds 97% of the time, measuring rolling three-year periods since 1960.

Even if we are close to a bottom for the current bear market cycle, it does not imply that investors should overweight stocks in their portfolios. Prudent investors keep a minimum of the next couple of years' worth of living expenses out of the market.

A good way to determine an appropriate allocation is to break down your portfolio into single portfolios for each year you expect to live. While the first two years may be in cash, the next few years might be in bonds and then the years that are ten or more years out can take more risk in stocks.

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