Bring On the Big Ugly

By Shannon Zimmerman | More Articles
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You'd better sit down for this.

Here's what currently in-vogue economist (and NYU professor) Nouriel Roubini posted to his popular blog back in August, and again -- because it remained disturbingly apt -- in September:

This is by far the worst financial crisis since the Great Depression, not as severe as the Great Depression but second only to it. ... We are only barely midway in the meltdown of U.S. and global stock markets.

Exit strategy?
Professor Roubini is in vogue for good reason. The guy has basically been right about everything since the financial crisis began to unfold in earnest, penning a paper back in February that scripted (per its subtitle) "The Twelve Steps to Financial Disaster" -- steps that, alas, have indeed been taken.

So, the best course of action is for investors to head for the exits, right?

Not to my way of thinking. Opening a "mattress account" and coming out from under the covers only when the coast is clear might seem like a good idea, but remember: Thanks to inflation, that "strategy" erodes your purchasing power, too. And what's more, ugly is as ugly does: Calling a market bottom -- and displaying a talent for clairvoyance that would allow you to emerge from your bed rest with an uncracked nest egg in tow -- is generally a loser's game.

A famous University of Michigan study showed that 95% of the market’s gains occur during only 1.2% of trading days. If you were out of the market on those days, you missed out on those gains. Similarly, researchers from the Financial Analyst Journal concluded that from 1926 to 1999, market timing lost to a simple buy-and-hold strategy in 99.8% of simulations.

This isn't to say that it's not possible to dodge the occasional bullet by picking the right stocks.

Consider Clipper (CFIMX), a mutual fund whose holdings include Costco (Nasdaq: COST  ) , CarMax (NYSE: KMX  ) , and Harley-Davidson (NYSE: HOG  ) . Though the fund has fallen on hard times of late, it posted a total gain of roughly 43.2% from 2000 through 2002, while the S&P 500-tracking Vanguard 500 Index fund (FUND: VFINX  ) declined by more than 37%.

Sequoia (SEQUX) was a bear-market bull, too. This fund, whose portfolio is anchored by the likes of Expeditors International of Washington (Nasdaq: EXPD  ) , TJX (NYSE: TJX  ) , and Lowe's (NYSE: LOW  ) , cranked out a total gain of 29.2% over that same period.

Skin in the game
That said -- and notwithstanding the numerous examples of funds that have successfully tacked through soggy (or worse) market periods -- the smartest strategy for most of us is to think long and hard about our asset-allocation game plan before plunking down our hard-earned investment moola.

Once you have a bead on how much of your personalized pie chart should be in cash and fixed income (based on your timeline and tolerance for volatility), you'll be much better equipped to make a call on the equity side of the ledger.

Allocation acumen is needed, too: Pity the folks who piled into financials last January on the assumption that surely the worst was behind us. Rather than making big, potentially brutal sector bets, savvy types like you should design a carefully calibrated portfolio that provides world-class exposure to domestic stocks and foreign fare, and to individual equities and mutual funds whose managers have proven over time that they have what it takes to beat the market over the long haul.

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This article was originally published on Sept. 17, 2008.

Shannon Zimmerman doesn't own any of the securities mentioned above. Costco is a Motley Fool Stock Advisor recommendation. CarMax is an Inside Value choice. You can check out the Fool's strict disclosure policy by clicking right here.