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What's Next

We answer the important questions that are on your mind.

One week stocks plunge 18%. The following Monday they soar 11%. Two days later they crater 9%. Talk of rampant bankruptcies, rising joblessness and maybe even another Great Depression fill the airwaves and cyberspace. That's probably hyperbole, but clearly the U.S. economy is on the ropes.

If all this leaves your head spinning, you're hardly alone. Never before have the nation and its citizens faced a financial crisis of such murky origins and elusive solutions. But in uncertain times such as these, it's important to avoid panicky moves and either stick to your plan or revise it thoughtfully and systematically.

To help you do that, we answer a baker's dozen of questions that are on the minds of many investors.


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1. Have the U.S. and foreign governments finally solved the financial crisis? It's too soon to tell, but you can't say the world's leading industrial powers haven't pulled out all the stops to tackle the root cause of the turmoil: frozen credit markets -- that is, the unwillingness of banks to lend to each other, to businesses and to individuals. Once it became clear that financial institutions and investors were not impressed with the U.S. government's $700-billion rescue plan, Western governments shifted into high gear, launching what economist Ed Yardeni calls "total war against the global credit crisis."


Among other actions, governments moved to install or expand bank-deposit insurance, inject capital directly into banks by buying ownership stakes -- in effect, partially and temporarily nationalizing a nation's financial infrastructure -- and guarantee that banks would make good on their loans to one another. The aim of these increasingly bold and dramatic acts is to restore confidence in the health of the major players in the global financial system and to encourage more lending.

2. What about the stock market? As investors learned of some of these remedies, they went on a buying spree, resulting in the October 13 "melt-up" in which U.S. stocks soared more than 11%. But the near-term future looks bleak. The economy is almost certainly in recession. How long or how severe it is hinges on how quickly the credit spigot begins flowing to bank customers. But a recession of any size or duration will put pressure on corporate profits. Kiplinger's expects gross domestic product to shrink through at least the first half of 2009, with the economy recovering weakly in the second half.

3. So should we take advantage of rallies to sell stocks, or at least refrain from adding to our stock holdings until the economy starts to turn? That's the $64-billion question. What makes investing tricky is that markets tend to anticipate the future. Bear markets end and bull markets almost always begin several months before the economy hits bottom and, typically, when the economic news is depressing.

The focus now is on whether banks feel confident enough to lend and whether they can begin to regain their financial stability. That was the purpose of those direct injections of capital into their balance sheets. If banks extend credit to their customers, the severity of a recession can be capped and it is possible to see an end to the economic misery on the horizon, even if it is months and months away. On such notes are bull markets born.


On the other hand, all recessions are accompanied by a litany of bad news. Every day brings revelations of lost jobs, lower profits and dim outlooks. These weigh heavily on investors' emotions, so it's possible stocks will continue to sink for months to come.

4. What about mutual funds? Funds are investment vehicles. They're as safe, or as risky, as the securities in which they invest. Of the major asset categories, stock funds are the riskiest, bond funds range from fairly risky to low-risk, and money-market funds carry the lowest risk.

5. Should I be worried that a money-market fund recently "broke the buck"? Probably not. When the Reserve Primary fund fell to 97 cents a share because of losses from its holdings of short-term debt issued by Lehman Brothers, it was the first time in 14 years that a money fund had broken the buck. So this is an exceedingly rare occurrence.

Still, short-term debt markets -- the area of the investment world where money funds roam -- have been so chaotic that we're reluctant to say that these funds are risk-free. The federal government's insurance program for money funds is more a bandage than a safety net (see What You Need to Know About Your Money-Market Fund).


If you want absolute safety, stick with Treasury-only funds, which are paying practically nothing. Or limit your money-fund investing to firms, such as Fidelity and T. Rowe Price, that have the wherewithal to make their shareholders whole should one of their money funds threaten to break the buck.

6. So how should I approach the stock market now? First, bear in mind John Kenneth Galbraith's famous line: "There are two kinds of forecasters: Those who don't know, and those who don't know they don't know." Because no one can accurately predict the day-to-day fluctuations of the markets, it's best to stick with things we can control. So, for starters, a bear market is a good time to take a hard look at your portfolio and gauge how much risk you can stand. Between October 9, 2007, and October 10, 2008, U.S. stocks, as measured by Standard & Poor's 500-stock index, plummeted 43%. Many individual stocks, of course, dropped far more. If a decline of this magnitude doesn't faze you, stick with your plan. If it leaves you queasy, you probably need to trim your allotment to stocks and add to your bond and cash holdings.

7. Are stocks still the best investment for the long haul? Yes. Most alternatives aren't terribly appealing. In mid October, the average taxable money-market fund yielded 1.5%. If you buy a ten-year Treasury note and hold it to maturity, you'll earn about 4% a year. You could buy a junk-bond fund that yields 11% or so, but you could easily lose principal. It's fair to question whether, over the next decade, stocks will earn their historic rate of return of an annualized 10%. The economy and hence corporate earnings will grow at a below-average rate as people and businesses unwind from their debt binge.

On the plus side, stocks aren't terribly expensive. In fact, it's at times like these that you'll find the best bargains -- you just have to be patient if they become even bigger bargains. Moreover, stocks are coming off a ten-year period in which the S&P 500 returned only 3% annualized. In fact, between March 24, 2000, when the technology-driven bull market peaked, and October 10, the index lost an annualized 4%. Bottom line: Stocks are due for a period of decent, if not scintillating, performance.


8. What do we need for a new bull market in stocks to begin? Two things. Probably the single most bullish factor would be signs that the housing market is bottoming. Falling housing prices and the credit crisis are intimately connected. Stabilization of housing prices, particularly in those states hardest hit by falling prices -- California, Florida, Arizona and Nevada -- would attract home buyers, improve consumer sentiment and lead to higher values for many of the mortgage securities that have so weakened global financial institutions. Also, banks must be willing, as well as able, to lend money. By guaranteeing repayment of interbank loans, the federal government is trying to break a cycle of fear among bankers.

9. I invest regularly in my employer's 401(k) plan and put the bulk of my money into stock funds. Should I stick with the program? Absolutely. If you stop investing in your retirement plan or you terminate any kind of a dollar-cost-averaging program, you're defeating one of the major purposes of systematic investing: It forces you to keep buying stocks when their prices are falling (that is, when they are on sale), something you probably would not do if you were left to your own devices. If you're worried about the investments in your 401(k) plan, it's better to tinker with its breakdown among stocks, bonds and cash than to stop your regular investment program.

10. Gasoline prices have come down, but prices on almost everything else I buy continue to rise, and I can't afford to max out my retirement savings anymore. What should I do? If your employer offers matching contributions, which most do, try to contribute at least enough to capture the match. It's a guaranteed return on your investment -- something that's hard to get these days. Miss out on the match and it's like walking away from free money.

11. Should I rebalance my portfolio? Yes, if you haven't lost your appetite for stock-market risk. Like dollar-cost averaging, regular rebalancing is designed to take the emotion out of decision-making. It forces you to sell the investments that have been performing relatively well and to deploy the proceeds into the relative laggards. If a year ago you placed $7,000 in a stock fund and $3,000 in a bond fund, chances are that the former is now worth about $4,200 and the latter is worth about $3,100. To restore the 70/30 split, you'd transfer $900 from the bond fund to the stock fund. Such a move might not pay off over the short term, but it almost certainly will over the long haul.

12. I never bothered setting up an emergency fund, figuring I could always tap my home-equity line of credit. But that's been frozen. What should I do now? The current economic problems are serving as a stark reminder to many Americans about the importance of saving for a rainy day. You should have three to six months' worth of living expenses stashed in a safe place, such as a bank account or money fund, so that you don't have to rely on credit cards to deal with an unexpected expense or to pay your bills if you lose your job.

Make your savings automatic by having the money deducted from your paycheck and deposited directly into your emergency account. If you have a hard time coming up with the extra cash to divert to savings, review your budget to see where you can cut back, such as entertainment and restaurant meals. (For other ideas on how to raise money in a pinch, see Need Cash? Where to Find It Fast)

13. What's the best I can do if I can't handle any risk whatsoever? Some bank money-market accounts are yielding more than 3.7% (go to to find top yielders). But because of upheaval in the market for short-term municipal IOUs, the best deals are in tax-free money-market funds. The average tax-free money fund yielded 3.4% in mid October, according to As of October 14, Vanguard Tax-Exempt Money Market fund (symbol VMSXX) yielded 4.1%. That's the equivalent of 6.3% in a taxable money fund for someone in the top 35% income-tax bracket.

NEXT: Bargains in Municipal and Corporate Bonds