FOOL ON THE HILL
Plummeting Portfolios

No one wants to see a portfolio implode, but it happens. You can make lemonade from lemons, though. Take some time to reflect and reevaluate after a disaster, and then set priorities and proceed systematically to rebuild.

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By Selena Maranjian (TMF Selena)
July 29, 2002

A few months ago, my parents' church burned down. It was a crying shame. The beautiful building, where so many had been married and baptized and celebrated, had been built in 1923, nearly 80 years ago. It featured lovely woodwork, stone walls, a slate roof, and a large and lively congregation.

The fire happened on a Tuesday morning. No one died. The building was a goner, though. Churches burning down are not exceedingly rare events. Burning churches happen -- all over the world. Sometimes by accident, sometimes in wartime, sometimes as arson, sometimes as hate crimes. There's even a National Coalition for Burned Churches, whose website states that 15 to 20 churches burn down each month.

It occurred to me that there are a lot of parallels between church burnings and investing -- at least with the last few years of the stock market (which now resembles, to some, a pile of smoldering ash). For example...

An unexpected catastrophe
No one expected that the church would catch fire. Similarly, no one expects the stock market to crash on any particular day or year. (Well, some may predict it, but at best, they're just making educated guesses, and at worse, baseless guesses.) Still, a rational person should certainly expect that a church burning can happen at any time, and that the stock market will crash now and then.

In the case of my parents' church, the possibility of a fire one day hadn't been dismissed -- the church leaders were prepared. They'd bought insurance. We investors can't exactly buy insurance that will replace the amounts we lose in the stock market. But we can take steps to insure that we're taking risks into account, and that we're not taking on more risk than we should. Even just learning more can be a form of insurance. The more you know, the fewer surprises you'll encounter.

Risk in investing is defined in different ways by different people. Academics will use formulas to try to discern an investment's unique risk vs. its risk that's tied to the overall market. Another way to look at risk is to think about allocation. If you are nearing 50 and you're investing like an aggressive 20-year-old, you may have taken on too much risk. To protect your portfolio against the loss of capital, you might want to have investments in safer instruments, such as bonds, CDs, or money market funds. One more way to look at risk is to simply review your holdings. Are most of those cement companies growing at 1% per year? Or are they mostly unproven companies with uncertain futures that might feature spectacular returns or spectacular flameouts? If so, perhaps some reorganization is in order.

Dangers
When facing disasters, or the aftermath of disasters, some feel tempted to act rashly. At my parents' church, one member of the staff reportedly ran back into the evacuated burning building to retrieve important papers. Fortunately, she made it out and spent no more than one day in the hospital. When faced with a plunging portfolio, you may feel an urge to sell things willy-nilly or to quickly invest in other things that suddenly seem cheap. But that's not a good way to face disaster.

Resist the temptation to act hastily. Take the time to know why you're selling or buying -- or to remember the riskiness of entering a burning building. If a stock seems to be a screaming buy, take a little time to look under its hood and make sure that you still like just about everything about it. It may be a lack of careful study and planning that got you into your investment inferno in the first place -- don't continue investing that way.

Priorities
With a burned church, a minister shouldn't summon his congregation to arrive the next Sunday with armloads of bricks and boards. Instead, the church has to start by reflecting -- then prioritizing. Needs and wishes must be listed and prioritized, and questions must be answered. Should the sanctuary or the education building be rebuilt first? Who needs to be found and hired -- a good lawyer? An architect? Before deciding whether the new building should be built bigger or just like the old one, the church needs to decide where services will be held in the coming weeks. Before rebuilding starts, debris must be removed and blueprints prepared.

Priorities are as important in investing. Step back and think: What are your overall goals for your portfolio, and are you on track to meet them? (If you think you need help with this question, consider finding a financial advisor -- we offer an inexpensive financial planning service to consider, too. And here's a little more guidance.) Do you have a master plan? If not, you should. Have you listed all your expected future financial needs (retirement, college tuitions, a trip to Antarctica, a llama farm), and will your current savings rate and investments get you there? Do you have a broker that best meets your needs? Do you have an emergency fund or a plan for how you'd face a financial crisis?

Once you begin addressing the big picture, drill down to the details. Examine your portfolio's components and your investing style. Where have you done well, and where are you failing? Do you need to learn more about how to value companies, or about how to recognize companies with strong competitive positions? Do you need a better grasp of when to sell? (Here's a bunch of useful articles and resources.)

A useful exercise is to write down on paper what specific investments your ideal portfolio would contain. Then ask yourself why you don't own those investments and whether you should overhaul your portfolio to optimize its potential.

Core competencies and beliefs
One of my parents' church's core competencies is music. They've always had a strong music program, with many choirs and concerts. So while the church spends a year or two in temporary quarters, it won't be doing so with a rented piano -- instead some money was spent on a temporary organ.

Investors often do best when sticking to companies and industries they understand and enjoy researching. It's also important to stay true to your investment beliefs. If you believe in the power of dollar cost averaging and want to invest small amounts regularly in stocks over your lifetime, then don't let a market slump frighten and stop you. Think it through and stick to your beliefs. If you believe that you don't know enough to invest in individual stocks yet and that you should stick to an index fund for now, don't jump into risky stocks.

Good from bad
Finally, much good can come from a disaster, although of course we'd prefer to get the good without the disaster. In the case of the burned church, there were many interesting and inspiring developments, such as:

  • Since the fire was broadcast by CNN nationwide, it drew the attention of many who used to worship at the church and helped some renew old connections to others.

      
  • Many people and organizations stepped forward to offer what they could to help. One business offered space for temporary church offices. A local elementary school housed the first few worship services after the fire, and now a Catholic school's auditorium is providing a more long-term temporary home for services. The fire brought the community closer together, and the generosity and kindness of others was humbling and overwhelming to the congregation.
  • Fire destroying the building reinforced the truth: What was most important was not destroyed -- the community and its faith.

Likewise in investing, disasters can yield benefits. For example:

  • Important lessons are learned most effectively through mistakes. You may lose $1,000 on an investment, but if you take the time to reflect and learn where you went wrong, you may successfully avoid making the same mistake later.

  • Depressed stock prices can represent bargains, as the stock of many strong companies becomes more attractive.

  • If you have questions or worries, drop in on our Fool Community discussion boards, and you'll soon find yourself overwhelmed by people eager to share time and knowledge with you.

Churches don't have to burn down to revitalize communities, and portfolios don't have to tank in order to be strengthened. But if disaster has struck your investments, be rational and make decisions carefully, working from a big-picture plan. In fact, begin doing so now, whether you smell smoke or not.

Selena Maranjian is smarter than a speeding bullet and faster than a tall building. To see Selena's complete stock holdings, view her profile. The Motley Fool is Fools writing for Fools