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How to Recover Your Portfolio

"Buy and hold" is supposed to be the way to long-term wealth.

No less than investing legend Warren Buffett advocates this method of investing in a company's future performance and profits, because it focuses on the reasonable -- and researchable -- fundamentals of a company's products, strategy, and management, instead of capricious valuing by millions of traders.

Add that to reduced trading costs and taxes, and, assuming reasonably good stock picks -- voila! Long-term wealth.

But then 2008 came along and put a serious smudge on that picture. Investors have given a hefty chunk of that long-term wealth back, and with a bleak near-term economic outlook, it doesn't look like those gains are coming back any time soon. Does that mean buy and hold is dead?

Nope. It only means you've got to take buy and hold one further step: buy and hold and buy.

We're not in Kansas anymore
The bear markets of recent memory have been relatively short, shallow affairs. And because of that, your portfolio would recover fairly quickly -- and with little effort on your part.

According to The New York Times:

Since 1982, the Standard & Poor's 500-stock index has recouped about 88 cents, on average, of every dollar lost in a bear market by the end of the first year of the subsequent bull market. By the end of the second year, that dollar would have been recovered, and then gone up an additional 18 cents.

But we can't count on that happening now. Why? Because the market has lost nearly 40% in 2008 -- substantially more than the bear markets we've seen in the past quarter-century.

Since World War II, the market has climbed 38% the first year of a bull market, 11% the second, and 4% the third, according to the Times. In previous post-bear rallies, that was enough not only to recover what you lost, but to get ahead. But if the market simply goes up from here in this same pattern, after three years, a $100,000 pre-bear all-equities portfolio will be worth only $96,000.

In other words, even if this bear market is over, and even if you're entirely in equities, and even if we're on the cusp of a multiyear rally -- all of which are best-case scenarios -- you still won't break even.

If you really want to get your portfolio back to where it was before the market turned south -- much less to where it would have been if the market hadn't turned at all -- you'll have to start buying.

Buy and hold … and buy
This is, after all, the best investing opportunity in 35 years. Famed investors from Buffett to Martin Whitman have proclaimed now a great time to be buying stocks -- but that doesn't mean everything is a good buy. While you might be tempted to scoop up big names whose share prices have been slashed by 30%, 40%, or 50% -- or more -- tread cautiously.

Many big-name stocks deserve their haircuts. Citigroup (NYSE: C  ) and Goldman Sachs (NYSE: GS  ) , to name but two, participated in the risky lending and leveraging that got us into this mess. Other companies' problematic business models and strategies blew up when the economy did -- General Motors (NYSE: GM  ) springs to mind.

Then there are the retail companies, which have been beaten down because consumers -- facing rising unemployment and limited access to credit -- are tightening their belts and cutting back on spending. Even the best retail stock is likely to suffer in a macroeconomic environment like this one, and some pretty good ones, such as Best Buy (NYSE: BBY  ) , Tiffany (NYSE: TIF  ) , Starbucks (Nasdaq: SBUX  ) , and Gap (NYSE: GPS  ) , have not been spared this year.

In other words, a cheap stock price isn't enough. You want a stock that will perform well from this point forward, and that means finding companies with the following:

  • Superior business models
  • Strong and lasting competitive advantages
  • Margins ripe for expansion
  • Growing market opportunities

In this market environment, it also means finding companies that produce goods and services that companies and consumers need -- not merely things they want.

The Foolish bottom line
Your portfolio can recover from this bear market -- but it's going to take some attention from you. Buying strong and promising companies now will help you recover those losses -- and get ahead.

But if you'd like to help it recover even faster, consider adding tools like options trading and exchange-traded funds (ETFs) to the mix. They not only help you generate more income, they can also reduce your portfolio's volatility and increase the benefits of diversification.

Those are the tools we're using -- and teaching -- at Motley Fool Pro, a $1 million real-money portfolio designed to combine core holdings, options, and ETFs to make money whether the market is up, down, or stagnant. If you'd like to learn more about the service -- and how you can use these tools to improve your own portfolio -- just enter your email in the box below.

Fool editor Julie Clarenbach owns shares of Starbucks but none of the other securities mentioned in this article. Best Buy and Starbucks are Motley Fool Inside Value and Stock Advisor recommendations. Gap is also a Stock Advisor recommendation. The Motley Fool owns shares of Best Buy and Starbucks. The Fool's disclosure policy holds on forever.

Read/Post Comments (5) | Recommend This Article (31)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 29, 2008, at 4:49 PM, showme wrote:

    When almost 70% of the market is held by traders that average only a 120 day hold period, can investors pursue a buy and hold strategy? Don’t we need a market that is 50% buy and hold investors?

  • Report this Comment On December 29, 2008, at 4:49 PM, FinancialFellow wrote:

    I, along with just about everyone else out there, agree that now is a very good time to buy stocks. So, the idea of buying even more than you otherwise would is certainly good advice. Then again, if you practice dollar cost averaging and are already allocating as much of your income to buying stocks as possible I don't know that you can really do much more.

    That said if you did have some extra cash now would certainly be a good time to throw more of it into the market - assuming you were willing/able to let it sit there for several years as the market recovers. I think you may be kicking yourself several years from now if you don't. As bad of a blunder as that may be I've made worse mistakes in the past:

  • Report this Comment On December 29, 2008, at 5:38 PM, tlbland2 wrote:

    As we approach the end of one of the worst years in history of the stock market there will be a lot of discussion of what investors should do. One piece of advice that we have heard throughout this debacle and will continue to hear is to "stay the course." No matter what happens in the market, there will always be proponents of "buy and hold" investing.

    The whole idea behind 'buy and hold' is that if you can find some really good stocks the inevitable bear markets will just be minor blips as your investment eventual compounds and turns you into the next Warren Buffett.

    There are a couple of problems that this very simplistic approach to building great wealth overlooks. First is that it is really, really difficult to find a stock that is worth holding for decades. Even Buffett himself has said only a handful occur in your lifetime. Finding the next Microsoft (MSFT - commentary - Cramer's Take) or Coke (KO - commentary - Cramer's Take) before it has made a huge move is one of the hardest things you can do in investing. I hear people talk about Apple (AAPL - commentary - Cramer's Take) being something that will build great wealth over the course of the next few decades. The stock was up 50-fold already at one point, so it's hardly an early-stage discovery.

    If we could easily identify the stocks that are candidates to go up 100-fold in the future, this whole investing thing would be tremendously easy, but obviously very few people have the capacity to tell the future to that degree.

    Which brings up the other major problem with buy-and-hold investing. If you are wrong, you are destroyed unless you have some sort of money management discipline. Further, in the inevitable bear markets that occur over the course of decades, rebuilding from your losses is hugely unproductive.

    Buy and hold is brilliant in a bull market, but even the best movers have a limited lifespan for stellar appreciation. The old adage is, "Don't confuse brains with a bull market," and a lot of people have learned that the hard way this year.

    The way to build wealth is about knowing how to sell rather than how to buy. Buying is the easy the part of investing. It is selling in a timely manner that is the key to compounding your money. Above all else, you must always protect your capital. If you can avoid having to make up losses, you are far ahead of everyone else who thinks that investing is a one-time "buy and hold" decision

    Rev Shark Article Today on Real

  • Report this Comment On December 29, 2008, at 7:25 PM, Bucks2407 wrote:

    tlb, you could not be more correct in my humble opinion and the whole buy and hold drivel completely drives me insane. Buy and hold defendable because it is similar to the famous pollster question. "What answer would you like me to come up with?"

    Buy and hold does the same thing. The last 10 years have stunk, so go back 20, or 30, or heck, 100. As we all have discovered it is ALL about knowing when to get out.

    Buy and hold is populuar because the huge financial services community is built on that very concept. Get a bunch of money under management and take 1-2% from all the portfolios.

    If that money is out of the market, there are no service fees to collect and a lot of financial advisors are looking for work, as they are now.

    I"ll sum up todays environment. Instead of the "greatest buying opportunity of a lifetime," I would say, "there will be better times to sell."

  • Report this Comment On January 07, 2009, at 10:00 PM, bparlette5701 wrote:

    I think that's a great idea and would if I could. What does a LOL of 70 do when her entire wealth is invested through a financial advisor for growth and income and has dropped almost 50% and some of those dividends she lives on are suspended?

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