Investing: Don't let fear flatten your portfolio
For investors, fall is the season of lushly painted leaves, golden morning light and hideous, soul-searing panics in the stock market.
This fall is shaping up to be no different: Looming military action in Syria, another fight about the debt limit, and hordes of the gibbering undead will all make this autumn peculiarly dangerous.
But you should be just as afraid of shaping your portfolios to fit your fears as you should be from the phone call originating in the basement. Defensive investments usually aren't designed for growth, and unless you time them well, you'll simply be sacrificing profits to panic.
Make no mistake: Investors have plenty to worry about this fall.
There's the historical record, of course. Some of the worst market crashes have occurred in September (1929) and October (1987). September remains the worst month for investing, according to the Stock Trader's Almanac, falling an average 0.6% since 1950.
(Read more: Attack on Syria: The worst and least-bad scenarios)
But there are plenty of other things to worry about, too. For example, emerging markets have been clobbered this year, and they're not getting much better. India's stock market has fallen 17% in August alone, and Indonesia has swooned 19.6%. India's currency, the rupee, has fallen about 22% this month. The last time emerging markets have plunged like this, in 1998, the Dow Jones industrial average fell 19% in less than two months.
But wait! There's more. In October, the U.S. will hit its debt limit, triggering a debate — seriously — about whether the United States should pay its honest debts. The debt limit pertains to money that Congress has already authorized to be spent, everything from Social Security payments to interest and principal on Treasury securities.The alternative to raising the debt limit is default — not just to the nation's bondholders, but to retirees and veterans, as well. People who think that default won't hurt the economy are the kinds of people who head into the basement to find out why the furnace is chuckling. The last time the U.S. grappled with this question led to the first downgrade of U.S. Treasury debt in history.
What else is in our closet of anxieties? Well, there's the threat that strikes in Syria could lead to wider conflict — which could, potentially, restrict the flow of oil to the U.S. Oil has already crept to near $110 a barrel because of uncertainty about the Middle East. In an economy where raises are few and jobs are hard to find, higher gas prices mean people have to cut back on spending elsewhere, slowing the economy further.
For those who worry about government expenditures, war is always costly. The U.S. and Britain fired about 161 cruise missiles into Libya to pave the way for warplanes. Those missiles cost about $1.4 million each, according to the Center for Public Integrity, meaning the barrage cost about a quarter of a billion dollars in hardware alone — not counting the cost of other military operations at the time. A no-fly zone over Syria would cost about $1 billion a month.
Finally, there's interest rates. The Federal Reserve has been buying bonds to keep long-term interest rates low. Low rates make stocks look more attractive than bonds or money market funds. The Fed's policy also keeps mortgage rates low, allowing homeowners to refinance their mortgages and reduce their monthly payments.
The Fed can't keep buying bonds forever, and sooner or later, it'll have to ease up on the monetary gas pedal. When it does, the stock market will react in much the same way you would if you found your grandmother in 47 pickle jars.
The question, then, is what an investor should do about all these potential horrors. The alternatives aren't appealing.
• Money funds or Treasury bills. Money funds invest in short-term, high-quality instruments and try to keep their share price at $1. The average money fund yields 0.01%, according to iMoneyNet, which means that you'll double your money in 7,200 years.
• Treasury notes or bonds. Barring a default — see above — Treasury notes and bonds are considered the safest investment in the world, if your goal is to get your principal back with interest. But a 10-year T-note yields all of 2.76%, which probably won't beat inflation in the long run.
• Gold. The yellow metal is hardly a safe haven, although it can be handy if the government collapses and you need to vamoose. At this point, however, it's about 40% cheaper than it was at its most recent peak, so it's mildly attractive as a short-term hedge against global unrest.
The drawback with nearly all safe havens, however, is that most aren't great long-term investments. You typically get higher long-term returns because you take on higher risk.
When you let fear overtake you, however, you cease thinking rationally about your investments, says psychologist and financial planner Brad Klontz. "When our emotional brain gets flooded, our rational brain shuts down," he says. At that point, you tend to be more susceptible to herd thinking — something that will get your portfolio flattened faster than Bambi fighting Godzilla.
Rational thinking might be to put 5% of your portfolio into gold as a kind of insurance policy against disaster. Irrational thinking would be to put all your money into gold, because you think the end of the financial world is nigh. "If you run the doomsday scenario to completion, you realize that you'd have to buy guns to protect your gold, because you'll need them once you're known as the guy with gold," Klontz says.
Your second-best protection in uncertain times is a widely diversified portfolio: stocks, bonds, cash, gold, real estate, commodities. You may not know which will go up and which will go down, but they probably won't all plunge at the same time.
Your first-best protection is a sense of optimism. The U.S. tends to do the right thing, even if only after trying every alternative first. In 20 years, your fears of 2013 will probably feel silly. Unless there's a zombie invasion, of course. Then all bets are off.
—By John Waggoner of USA Today.