How to Succeed When the Market's Down

There's really just one reason you invest in stocks: to make money. But when the investing climate doesn't cooperate, it's just as important to lose less when markets are falling as it is to make more when they're up.

As simple as that seems, it's hard to adjust your thinking toward capital preservation in down markets. When you start thinking about cutting your losses, you inevitably start playing the "if only" game -- if only you'd sold all those stocks and put everything in cash, you'd be flat or slightly up on the year rather than down 10% or more.

But unless you know the secret to timing the market -- something very few people have managed to do successfully over the years -- you're going to have to keep part of your money in stocks, through thick and thin.

Nowhere to hide
With individual stocks experiencing huge volatility -- Fannie Mae (NYSE: FNM  ) is just the latest example -- many investors choose actively managed mutual funds in the hope that fund managers will make better decisions than the overall market. Unfortunately, most stock funds haven't found a way to earn positive returns this year. A look at some of the largest stock funds gives you an idea of the red ink fund investors are seeing lately, despite strong long-term results:

Fund

YTD return

5-Year Annualized Return

Growth Fund of America (AGTHX)

(9.8%)

10.1%

Fidelity Contrafund (FCNTX)

(10.5%)

13.0%

Dodge & Cox Stock (DODGX)

(18.4%)

8.4%

Fidelity Magellan (FMAGX)

(15.5%)

6.4%

Vanguard 500 Index (VFINX)

(13.7%)

6.7%

Source: Morningstar.

Just like the overall market, stock funds inevitably will have winners and losers. But if your fund manager has good stock-picking ability and puts money in the right sectors, your fund will do better than the overall market.

For example, Fidelity Contrafund has done well with its sector weightings. An above-average allocation to natural resources stocks EnCana (NYSE: ECA  ) and Goldcorp (NYSE: GG  ) has given the fund a vital edge over its peers. A strong performance from top-10 holding Genentech (NYSE: DNA  ) has also played a part.

In contrast, the Dodge & Cox fund has faced a triple whammy in its sector choices. With financials struggling, top-three holding Wachovia (NYSE: WB  ) is down more than 60% in 2008. Exposure to health insurer WellPoint (NYSE: WLP  ) and cell-phone maker Motorola (NYSE: MOT  ) has also contributed to substantial losses.

Win by losing less
At first glance, it may not seem like a victory to lose "only" 11% when the overall market is down 14%. But over time, that 3% edge in losing years makes just as big a difference as having strong returns in up years.

Here's a simple illustration. Say the market goes up four years out of five by an average of 12%, but during that fifth year, it drops 10%. That comes to an overall average return of 7.2% and turns $10,000 into more than $160,000 over the course of 40 years.

But say you find a way to reduce your losses during those bad years to 7% while keeping the same gains during good years. That small improvement boosts your nest egg by nearly a third, to more than $210,000.

Sure, it's sexier to show huge gains in your portfolio when things are going well for the market. But a fund that outperforms during bear markets is just as valuable -- if not more so -- than a fund that outperforms during bull markets. By changing the rules and focusing on minimizing your losses during bear markets, you can have a dramatic impact on the ultimate value of your investments when you reach the finish line.

For more on using mutual funds to protect yourself from the bear, read about:

Looking to minimize your losses? If you want the inside scoop from the industry's top experts on what to buy, the Fool's Champion Funds investment service could be your new best friend. Try it our free for 30 days -- with no obligation to subscribe.

Fool contributor Dan Caplinger is seeing losses in his portfolio this year, but he hopes they'll stay under control. He doesn't own shares of the companies mentioned in this article. WellPoint is a Motley Fool Inside Value recommendation.Try any of our Foolish newsletters today, free for 30 days. We never change the rules with the Fool's disclosure policy.


Read/Post Comments (3) | Recommend This Article (5)

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 July 11, 2008, at 3:04 PM, aputtman wrote:

    Is it still helpful to ship wealth producing jobs overseas and import LEGAL aleins (H1B's) to work in the high tech sector? Both the presidentail candidates think so. But nobody asks them about it. What precentage of the containers that come into this country are inspected? I think it's about 1 percent. We basicaly have no boarder security.

  • Report this Comment On July 11, 2008, at 6:03 PM, Boo2007 wrote:

    В этой статье как раз отмечаются нужные советы, что нужно делать американским бизнесменам сегодня.

  • Report this Comment On July 11, 2008, at 7:38 PM, astuesser wrote:

    Why settle for a loss of "only 11%" when you can invest in alternatives that actually generate a positive dividend regardless of what the market is doing on any given day? I've taken all of my funds out of the stock market for now and have put them into the alternative investments that my firm works with and I am generating positive and consistent cash flow even in these hard times. Most of my investments are paying between 9 and 12%. I would never settle for "winning by losing less" that seems to be a fool's strategy.

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