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YOUR NEXT MOVEInvestment strategies for a slowing economyAdmit it. You haven't been this worried since--well, it's hard to recall when. The crash of '87--that was a shocker, no question. And the Persian Gulf War three years later was a concern. But after eight years of mostly blue skies and green grass, suddenly last summer you discovered frightening threats to your money and investments in what seems like every time zone. There's deflation in Asia. Default in Russia. Devaluation in Latin America. Looming impeachment proceedings and recession in the U.S.--the bad news just keeps on coming. Bill Aurilio knows the feeling. In many ways, the 32-year-old controller of U.S. Dermatologics Inc., a small drug company in Lawrenceville, N.J., is lucky. He's the father of newborn twins, Jimmy and Jordan, plus nine-year-old Joshua. He and his teacher wife, Karyn, are building a $350,000 home near Princeton. To make the $40,000 downpayment, the Aurilios cashed out much of their stock holdings last July at the market's peak. Yet Aurilio isn't crowing. He had believed his stocks were headed higher and that by selling in July, he'd be leaving 10 grand on the table. Instead, one stock he sold at $21, Intelligroup Inc. (ITIG), sank below $11. Another he let go at $8, Ariel Corp. (ADSP), fell to nearly $2. Now, he wonders, ''What if things keep going in that direction? What if the housing market loses value? All of a sudden, I've turned into the most conservative person in the world.'' Is the market turmoil of the past few months making you, too, rethink the risks to your wealth? If so, good for you. Balancing risks against potential returns is the essence of successful investing, but it's a priority people tended to forget as stock prices kept soaring. Now, with the market in another frame of mind, BUSINESS WEEK aims to help you understand not just the opportunities ahead but also the risks. And there are plenty of the latter these days. The Federal Reserve's recent interest-rate cuts have many people wondering if Alan Greenspan knows something about the economy the rest of us don't. In any event, those blue skies are turning cloudy. Some economists see U.S. economic growth slowing to 1.9% from 3.5% in 1998, and many others think it'll be even less. Corporate profits may expand less than 3% next year, and as for growth in the once-booming emerging markets, forget it. Sorting all this out isn't easy, even for big-money pros. Consider the answers we heard after posing this question to two of Wall Street's brightest stars, Fidelity Investments' Peter S. Lynch (page 122) and PIMCO Advisors' William H. Gross, whose $140 billion in assets makes him the nation's leading bond investor. Should individual investors worry about Japan, Brazil, deflation, liquidity squeezes--all of that? ''Tune out. Tune out. They should tune out all this stuff,'' Lynch replied. Said Gross: ''This global contagion is the most important and dangerous phenomenon to financial stability that we've seen in the past 60 years. Investors have to be concerned and aware of it, and make their investment strategies based upon it.'' ''VERY NEBULOUS.'' Who's right? Both are. But which answer applies to you? It depends on who you are. Can you afford to focus on tuning your portfolio to the threats of recession and deflation, as Gross suggests? Not if you haven't first arranged your own basic financial security. Not if you aren't clear why you're investing and when you'll need your money back. ''You ought to say to yourself, 'Do I need this money in the next year?''' Lynch says. If so, forget stocks. ''That should be true at all times--when the market is going up or the market is going down.'' Look at it another way: Are you ready to exploit the temptingly low prices of stocks in places like Japan? You may be--if you truly can afford to shoulder the risk of waiting many years for a profit. Brandes Investment Partners is no household name, yet the $20 billion San Diego firm has run up since 1974 one of the best records among international investors. Over the past 10 years, ended September, Brandes' institutional Global Equity product returned an annual average of 14.9%, net of fees, vs. 9.7% for the Morgan Stanley Capital International World Index. After cashing in fat profits this year on such European stocks as Alcatel (ALA), which it started buying back in 1993 when the Continent was out of favor, Brandes now is focusing on big Japanese companies like Hitachi Ltd. (HIT), which Managing Partner Glenn R. Carlson reckons is selling for 60% of book value. ''If we had a 12-month view, we absolutely would not be investing in these companies,'' says Carlson. ''But with three to five years, we don't think there's a lot of risk.'' Indeed, knowing where to focus your worries gives you part of the answer to how much risk you can afford to take. Are the risks you face peculiar to you? Or are they external ones we all may endure? The rest of the answer comes from a process that's every bit as personal: a simple gut-check, something you can do by scanning the asset allocation table above. Whatever your age, do you really want your entire portfolio in stocks? History says that's the route to the biggest returns. But you'd better be prepared for money-losing years, a fate all-stock investors would have suffered nine times since 1956. ''Risk is very nebulous,'' says Luke M. Collins, managing director of KPMG's Investment Consulting Group in Chicago. ''I don't care if you have a 50-year time horizon. If you can't sleep at night because of something Louis Rukeyser said, then you've taken on too much risk.'' Stomaching steep investment losses is something that advisers like Robert F. Mewshaw find comes harder to rookies. His firm in Towson, Md., Van Sant & Mewshaw Inc., oversees $150 million in personal accounts, and after clients got their August statements, Mewshaw's phones began ringing. ''People who've been with us a long time, 15 years or so, we didn't get any calls from,'' Mewshaw says. ''But newer clients? They were pretty astounded that their accounts went down. They realized for the first time, 'Hey, I can lose money here.''' As you reflect on your proper level of investment risk, it's worth stopping to ask how the sight of losses in your recent mutual fund or brokerage statements left you feeling. If you felt sick over the possibility that you may now have trouble meeting some coming obligation--a downpayment on a house, say, or a tuition bill--then you need to lessen your risk. Allocate less of your assets to stocks. And make sure your money is in places you can tap into when you need it. By the same token, perhaps paper losses have only left you eager to buy into depressed markets with cash you've patiently sat on for just this moment. Or maybe you have fresh cash--your paycheck-by-paycheck retirement plan investments, a bonus, or some other windfall--to put to work. Of course, you want to invest in today's best opportunities, but first you need to ask yourself a question. Will these investments sit in a regular taxable account or in a 401(k) or another tax-deferred account? The answer is crucial. A move that's smart in one may be unwise in another. ''I know people who trade their taxable accounts, and I never understand that,'' notes Brian Rivotto, a financial planner and partner with KPMG in Boston. Since most unsheltered sales of stocks (page 124), bonds (page 132), or mutual funds (page 128) are taxable events (page 135), focusing your active portfolio moves in an individual retirement account or other tax-deferred plan usually makes the best sense. For that reason, in rebalancing your portfolio among equity, fixed-income, and cash assets, it's best to do as much selling as possible within your tax-deferred retirement accounts. Trading there gives you no tax benefits from bailing out of losers. So trim your retirement account's winning assets--most likely bonds--and buy more in the losing categories, especially small-company and international shares that have suffered so in the past year. QUALITY PAYS. Although in recent weeks small-company stocks have perked up, they still trade at historically low price-earnings multiples, says Ned Notzon, whose job as co-manager of T. Rowe Price's Spectrum funds includes divining which areas of stock and bond markets to favor. The risk: If the U.S. slides into recession, small caps will bear the brunt. He also likes international equities, as does KPMG's Collins, particularly those in battered emerging markets, where he recommends investing 5% to 10% of a long-term portfolio via a closed-end, non-country-specific fund. ''When I talk to people about emerging markets now, they kind of roll their eyes,'' he says. ''They think, 'What are you, crazy?' But you've got to believe the long-term prospects for these countries are good.'' Likewise, the contrarians at Brandes are finding values in Asia for the first time in many years, and not just in Japan. Brandes is also buying in Hong Kong, specifically conglomerate Swire Pacific Ltd., the majority owner of Cathay Pacific Airways. It is also stocking up on shares in Brazil's giant utility holding company, Eletrobrs. ''It's sort of AT&T prior to the breakup,'' Carlson says. He figures at a market value of $12 billion, Eletrobrs traded recently at less than half the value of its distinct businesses. When you rebalance your portfolio, you'll have to address your bond allocation, too. If you have fresh cash to invest or if you're resetting your asset allocation more conservatively, look at your taxable account first. If your federal tax rate is 28% or higher, you probably should be holding only tax-exempt municipal bonds or muni-bond funds. Munis typically pay 80% or 85% of the yield on Treasuries. But right now, they're unusually cheap, yielding in some cases 100% or more of taxable Treasury debt. ''If I can buy a single-A muni at the same yield tax-free as a triple-A Treasury,'' says PIMCO's Gross, ''there's no doubt which one I'd buy.'' In your retirement account, however, the tax-exemption on a muni will do you no good. Instead, Gross advises focusing on high-credit-quality, intermediate-term taxable government bonds, or a mortgage-backed bond fund limited to such government-sponsored issues as Ginnie Maes. Here's why: If, as Gross believes, a U.S. recession next year is increasingly likely, higher-credit-quality bonds will endure better. In addition, while Gross sees the Fed cutting short-term interest rates further in coming months, he thinks the 5% recent yield on long-term Treasuries already anticipates this. Instead, Gross advises, ''focus on maturities in the 5- to 10-year intermediate category,'' whose prices would move up more sharply. What if you're more bullish than Gross on the U.S. economy? Reach for the higher yields paid by longer-term bonds and lower-quality issues, even junk. In all of this, though, remember there's a thin line between resetting your portfolio's asset allocation and trying to time market bottoms and tops--a hazardous exercise. If you arrived at a comfortable asset allocation a year ago or more, bring your portfolio back to those proportions and relax as best you can. Fidelity's Peter Lynch suggests you should say, ''This is what I'm happy with. This is a mix I'm content with, and I'm willing to ride with this for the next 5, 10, 15 years, and I'm just not going to worry.'' And what about Bill Aurilio? He's dealing with his worries via a two-track plan: In his taxable account, he has already bought back some stocks he sold at far higher prices last summer. But he's also saving more and keeping it in a money market account and paying closer attention to risk. ''I'm focused on what I can do to make sure that I don't lose the rent,'' he says. ''I'm pulling everything back.'' In his retirement account, meanwhile, Aurilio is still 100% in stocks, and he aims to leave it that way even though it's down by 25% since July. ''If I were concerned about taking the cash out next year to retire, I'd be in Treasuries,'' he says. ''Even if we're in for a couple of rough years, 10 years from now the market will be higher and stronger And better. Why miss that?'' For decades, investing this way, with patience and a full appreciation of the market's risks, has paid off handsomely. Once you've calibrated your risk tolerance, the balance of our Special Report can help you make the right choices amid this world of worries.
By Robert Barker RELATED ITEMS
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Updated Oct. 29, 1998 by bwwebmaster
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