Is the United States economy in recession or recovery? Ask five financial experts and you'll probably get five different answers. However, that doesn't mean you can't be prepared for either event.
Start by figuring out the risk level of your current portfolio. For starters, tally up the total value of all your investments. Then, sort them into three groups -- stocks, bonds, and cash equivalents like such as Treasury bills and CDs. Divide the amount in each asset category by the total amount of your portfolio. For example, if you have $100,000 -- $85,000 in stocks, $10,000 in bonds, and $5,000 in cash, the breakdown would be 85% stocks, 10% bonds, 5% in cash. (This is a rather aggressive portfolio mix probably suited to young investors or those with a high risk tolerance.)
By looking at the previous bear market of 1973-74, this portfolio would have been down 34% (according to Parade magazine). If you look at another time period, say from January 1950 through December 1997, the largest loss in any one-year was 30.2%, reports a study by T. Rowe Price. Would you have panicked and sold at a loss? That's the test that investors face in a bear market. If the only way you could get a night's sleep would have been to cash out, then it's necessary to make some changes in your asset allocation.
First, move any money you need for supplementing your income or for short-term goals to a money market account or CDs. Second, consider a more conservative asset mix -- perhaps 60% stocks/40% fixed-income for someone with a moderate risk tolerance and 50% stocks and 50% fixed-income for someone who is more conservative and cautious. Third, make sure your portfolio is well diversified -- stocks in both big and small companies, domestic as well as some foreign stocks, different industries, etc. Hold bonds of short and intermediate maturities.
Older investors, in particular, should think carefully about their risk tolerance. An investment risk tolerance quiz is available on the Rutgers Cooperative Extension Website = www.rce.rutgers.edu/money2000 (click on Resources). The quiz can help you assess your capacity to withstand investment losses.
If you are unconcerned about recession, stick to your asset allocation come what may. If you are nervous about it -- even though your head tells you that a particular asset allocation is appropriate for you, say 60% stock, 40% fixed income -- you might take 10%-20% of your stock allocation off the table by selling the biggest winners that will more likely take the more serious hits. Then dollar-cost average the money you took out back into the market over a one-year period into solid companies in areas of the market that are temporarily out of favor. Dollar-cost averaging means investing a regular amount at a regular time interval.
Whether we are in a recession or not, the fundamentals of successful investing remain unchanged. Buy good companies and hold them, diversify, and be prepared to take some hits during market downturns.