Monday, September 22, 2008

Wall Street in Turmoil: What To Do

I'm going to resist the temptation to delve into politics and criticize the big mess on Wall Street. There's plenty to criticize but no one (in power anyway) cares what I think.

What is an individual investor to conclude from the situation? I see these things:

  1. The rating agencies who handed out AAA ratings like candy are not to be trusted. The paranoid among us note that they are paid by the issuers of securities and a good rating helps sell them. Giving a AAA rating to investment banks with 30:1 leverage ratios is clearly bogus, as a 4% drop in asset values wipes them out. Like most people, they simply thought that real estate prices would rise forever. Repeat after me: Trees don't grow to the skies. Anytime anyone asserts that a market will never fall, run for the exits.
    It is actually safer in invest in lower rated securities, assuming you have diversification as in a mutual fund. There you get a higher interest rate to compensate for the higher risk. AAA securities may or may not be safe, but you can be sure they will pay a low rate.
    Trust your own instincts as to what is safe and what is not.
  2. Now that we are into a bear market, it's time to check on asset allocation. One rule of thumb I like to use is to have a certain percentage of your assets in common stocks, declining as you get older and less able to recover from a loss. I like the rule of 110 minus your age for the percentage of your net worth in stocks. If you've been managing your asset allocation, the market drop may mean that you now have too little in stocks. In other words, it may be time to buy. How can you buy with all these screaming negative headlines? Well, that's a good sign for a buyer. When everyone is patting themselves on the back, that's the time to sell.
  3. What to buy? I've noticed that our old friend the tech stocks have taken a pretty good pounding, even though sales are holding up and they rarely depend on borrowed money. I'll be looking them over for bargains.

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