Level-Headed Tips for a Volatile Market
Avoid hot small companies, diversify, consider index funds...
You'd think the Dow's 512-point drop Monday, followed by a 288-point rise on Tuesday, would be enough to make anyone queasy. But investment advisers say their small-business clients seem relatively unruffled by the turbulence -- so far. "The sun is still shining. Cars are driving by," says Kurt Brouwer, president of San Francisco money-management advisers Brouwer & Janachowski Inc., who says he has fielded only a handful of calls. "Most people who are working don't have time to freak out."
But that doesn't mean it's time to be complacent. Unlike the average wage-slave, entrepreneurs have most of their wealth tied up in one illiquid "emerging-growth" company -- their own. And when it comes to retirement and other personal investments, "they tend to like small, fast-growing companies -- like their own," says Ronald W. Roge, a financial planner based in Bohemia, N.Y.
That spells trouble in today's volatile market conditions. Companies with small market capitalizations have been devastated this year. Even after Tuesday's rebound, the Russell 2000 index of small-caps closed down 20.3% for the year to date, compared with a nearly flat Dow Jones industrial average.
The lesson for small-business owners: Diversify, says Ann Diamond, a New York chartered financial consultant. "You need to balance everything in your life, and even if you are putting 100% in a private business, you still need to be looking at your future." When it comes to retirement or sending the kids to college, you're going to need assets that are more readily available and less subject to sharp swings. It may seem dull, but Diamond says the place to go is a good, old-fashioned mix of mid- and large-cap stocks. "There is a place for boredom, and this is one of them," she says.
In that vein, index funds that track the broad market remain good choices. For starters, their long-term record remains excellent. They've beaten most actively managed funds over the past decade, and they're widely available without a load and have low annual carrying costs. And while indexing is often disparaged as "passive management" -- a virtual epithet among entrepreneurs -- monitoring your portfolio is as simple as looking at the day's headlines. That leaves you more time to attend to your real business. Among the better offerings: Vanguard Index Trust 500 Portfolio, which tracks the big-cap Standard & Poor's 500-stock index; and Vanguard Index Total Stock Market, which mimics the performance of the much broader Wilshire 5000-stock index.
Most advisers suggest sticking to mutual funds, but Lewis Altfest, investment adviser and head of L.J. Altfest & Co. in New York, is also partial to stalwarts such as Kellogg Co. in the food group and oil giants such as Exxon Corp. Those companies have price-earnings ratios of about 21 to 23 and returns on equity of 55.8% and 18.1%, respectively. "You want to be in the staples that haven't been carried forward like Coke or Disney, where the values are out of whack with historic valuations," he says. Coke, for instance, sells for 42 times trailing earnings, and Disney's p-e tops 28.
As for small caps, it may be painful to sell just now, but Altfest says they should be no more than 25% of an entrepreneur's portfolio. And be selective. If you do own small caps, he recommends cutting back on more volatile technology stocks in favor of solid companies in out-of-favor industries.
Any losses you do realize while rejiggering your portfolio can come in handy at tax time, points out Gerry L. Golub, chairman of American Express Tax & Business Services. He notes that losses can be deducted against any gains, thus reducing your liability. One caveat: You must wait 30 days before buying the same stock again. Otherwise, the IRS won't regard it as a real sale, just a tax maneuver.
Bonds, that conservative staple, should also be on your buy list for the sake of diversity, says Joel S. Isaacson, whose Fifth Avenue advisory firm in New York bears his name. "Five months ago, no one wanted to own bonds. People wanted to be 100% in the stock market, and they used to laugh when we said you'll get 4% or 5% tax-free from municipal bonds." Now, of course, those who did buy are sitting on top of substantial capital gains because bond prices have been driven up by investors looking for a haven. But here, too, don't be complacent: Long-term bond prices can also be volatile, and Isaacson prefers a mix of short- and medium-term notes because their value doesn't fluctuate as much.
Of course, many small-business owners not only have their own investments to worry about but those of their employees. And their choices for the company's fund tend to reflect their own appetite for risk because they either manage the money themselves or choose the mutual funds or advisers, says Kurt Brouwer. "They tend to have a huge influence on the plan."
Current market conditions bring into sharp focus a business owner's fiduciary responsibilities and restrictions. Steer clear of giving advice to employees who may be panicky, counsels Diamond. Few small-business owners are qualified to give advice, even if they consider themselves to be savvy investors, and you might get sued if your advice turns out to be wrong. Diamond and others recommend bringing in an independent financial counselor to tell employees what their options are and to teach them long-term investing strategies.
As for the owners themselves, Lewis Altfest says most of his small-business clients are resisting the impulse to panic. But they do need reassuring. "Most of them just want to hear my voice," he says.
Of course, for small-business owners who don't need to take cash out of the market now, Monday's losses or Tuesday's gains are all on paper. The issue for them isn't how spooked stockholders are over the market, it's whether their customers get spooked about the economy.
By Jeremy Quittner and Julia Lichtblau in New York
To: PERSONAL BUSINESS