by Archie M. Richards, Jr., CFP^®
July 29, 2002

Charles, who's in the construction business, writes that, in the spring of 2000, at the market peak, he acquired two mutual funds of large growth stocks. Of all stock groups, large growth stocks have been hit the hardest. He hasn't sold, and he's suffering. He asks whether he should hang on or sell the two funds and acquire the Vanguard index funds this column has recommended, as shown below. (Index funds don't try to beat markets; they just equal them.):

30 percent Total Stock Market Index Fund

30 percent Total International Stock Market Index Fund

20 percent Real Estate Investment Trust (REIT) Index Fund

20 percent Long Term Bond Index Fund.

I'm sorry about the losses, Charles. But I suggest you switch now. Treat investment decisions as you would your business. Don't look back. The time to adopt the best investment approach is always now.

The above funds cover separate investment classes broadly - 3,000 U.S. stocks, 1,500 foreign stocks, just about all U.S. REITs, and 194 bonds. The up and down cycles of these groups differ from one another. When one is falling, another may be rising, cutting the risk of the whole.

If your retirement plan doesn't offer Vanguard funds, acquire similar ones.

Rebalancing is key. If you need money to live on, remove it every 13 months (to avoid short-term capital gains). Take the money from the funds than have done better than the others.

If you don't need money to live on, rebalance every 13 months anyway. Compute the value of the entire portfolio. If the percentage of each fund has changed by less than 30 percent, leave them all alone.

Some of the funds, for example, were originally 30 percent of the whole. 30 percent higher than 30 percent is 39 percent; 30 percent lower is 21 percent.

When rebalancing, if the domestic and foreign stock funds (originally 30 percent) fall between 39 and 21 percent of the whole, they won't require change.

The REIT and bond funds, originally 20 percent, could each have ranges of 26-14 percent.

But if any fund falls outside of the 39-21 or 26-14 percent ranges, switch money among the four funds, returning them roughly to the original 30, 30, 20, 20 percentages. Rebalancing is an automatic system to buy low and sell high.

In the last two years, both REITs and bonds have gained while domestic and foreign stocks lost. Investors who owned all four groups would have lost considerably less than those who owned just stocks.

If rebalancing were done now, investors would reduce the REIT and bond funds and add to the domestic and foreign stock funds.

Asset allocation with rebalancing: It's the best you can do.

Are the bad news and falling stock prices inducing you to sell? If you do, remember that someone else is buying. You may sell because you expect prices to decline. The buyers expect prices to rise. Maybe they're the ones who'll be right, not you.

But assume you prove correct after all. You sell and prices go down. Even then you have problems.

Let's say you sell when investors are 80 percent bearish. Prices then fall. But the declines make investors even more bearish. Now they're 100 percent pessimistic.

Having sold when others were 80 percent bearish, would you step in and buy when they're 100 percent bearish?

Probably not. You're likely to wait until the others are only, say, 50 percent pessimistic. But by then, prices are higher than when you sold.

This is when you lose confidence. You say to yourself, "I guess I'm no good at this game." Therefore, you delay purchasing until you're absolutely confident about the future. But investors may then be 70 percent optimistic, with prices a great deal higher - so high that they're getting ready to start down again.

You were initially correct when you sold. But you then forfeited big gains.

Don't turn investing into a game. Ride through bear markets. They don't last forever.