SmartMoney.com - Common Sense
Zen and the Art of Portfolio Maintenance
By James B. Stewart
Tuesday February 27, 11:48 am Eastern Time
DESPITE MY OPTIMISM of last week, the Nasdaq dropped to a new low for the year, plunging through my next buying threshold of 2200. With the average at about 2150 on Friday afternoon, I stepped in with my latest buying program.
Before getting into the details, let me remind you that despite the prevailing mood of gloom, it has been quite a while — two months — since we last hit a buying threshold. In mid-December, 10% drops seemed to be biweekly occurrences. So the pace of the market's decline has slowed considerably. That has given investors like me the time both to save some more cash for investment and, if you took my advice last month, raise some additional cash by selling into the brief January rally. So I hope you're well positioned for this most recent drop.
Just about every stock I've recommended and wanted to own has now sold off. While it isn't pleasant to watch the value of your portfolio decline, I want to stress again that a falling market represents an opportunity for investors more interested in adding to their holdings than in liquidating. Depending on your life expectancy, that should mean just about everyone under 60 years old, and plenty of people over 60 as well. I have wanted to add to my holdings in data storage and fiber optics for over a year, but the prices in these sectors were prohibitive. Now I can actually start building these positions at prices I can afford. Stocks are like anything else you want to buy that suddenly goes on sale. Most of our purchases depreciate 50% or more the moment we walk out of the store. So why do we get so upset when a stock goes down 10% or 20%, especially when that decline may be temporary?
Another important reason to have fixed buying and selling points along the lines I recommend is asset allocation. With my investment funds I try to maintain a target allocation among categories of investment (cash, equities and bonds) and among sectors within the stock market. These are careful choices to which I have given considerable thought, so it's important not to let the vagaries of the market make them for me, which is what happens to too many people. This has taken vigilance for the past few years in particular, as tech stocks soared, swelling as a percentage of my portfolio, and then plunged, causing other categories to expand. I have to rebalance my portfolio periodically to restore the allocation I want. Like many investors, I fell behind during the past few years, and after the tech collapse, I've vowed not to let it happen again.
Portfolio rebalancing can be done at any time. Major institutions do it every day. For individual investors, who may incur significant transaction costs, four times a year is adequate. But I find it especially useful to examine asset allocation whenever I reach a buy or sell threshold, since the exercise invariably helps me decide what to buy and sell.
By last Friday, when I realized it was time to buy, my cash position had grown to more than my targeted 10%, both because of additional savings and because of the overall decline in value of the equity portion. Bonds had also increased. So it was time to consider buying stocks even if a target hadn't been reached. Within my equity portfolio, though, things weren't quite what I might have suspected. Since I last examined my allocations, at the end of last year, technology holdings overall had declined, though not as much as I would have guessed. So had pharmaceuticals, partly offset by gains in biotech. Financial, manufacturing and retail had gained. But when I looked more closely at technology, I saw that subcategories had diverged, with the semiconductor and semiconductor-equipment sectors actually having risen. Two of my best-performing stocks turned out to be Compaq (NYSE:CPQ - news), up nearly 40%, and Microsoft (NASDAQ:MSFT - news), up 37% so far this year. The big losers were networking stocks like Cisco (NASDAQ:CSCO - news) and Sun (NASDAQ:SUNW - news), down 33% and 26% respectively; storage companies EMC (NYSE:EMC - news) and Network Appliance (NASDAQ:NTAP - news), down 33% and 48%; and my biggest loser was communication-chip maker Applied Micro Circuits (NASDAQ:AMCC - news), down 53%. Nortel (NYSE:NT - news) was off a precipitous 40%, but in the same telecommunications sector, Worldcom (NASDAQ:WCOM - news) had gained almost 40%.
As always, I asked whether I still wanted to own these stocks. The answer was yes. So I rebalanced by buying stocks with some of the biggest declines, both to increase positions (Network Appliance and Applied Micro) and to restore one (Nortel). I also added to small positions in Inktomi (NASDAQ:INKT - news) and Analog Devices (NYSE:ADI - news), even though they haven't gone down much since the first of the year.
This isn't an exact science. I still haven't gotten the tech sector back to my target, but I'm close. And cash is again below 10%. This is important, since over time, cash has been the single worst performing asset and the most common culprit in below-average returns. My next buying target will arise if the Nasdaq breaks below 2000, at about 1930. I'm certainly not hoping we get there, but whatever the market delivers, I'll feel prepared. |
