The time for another Wall Street ritual isupon us. As the sunny season heats up,physician-investors start hearing aboutthe traditional summer rally. It's early this year, ormaybe it's going to be late. Actually, the summerrally (ie, stocks doing better just before or duringthe summer) is another one of thoseWall Street myths that sounds good,even reasonable, but historical datadon't show any consistent pattern ofsummer rallies. It depends on what periodof history you look at, what you calla summer rally, and so forth.
Instead of looking for or discussingsummer rallies, this year you may wantto do some summer cleaning. If you'relike most physician-investors, for thepast few years, you've dreaded your brokeragestatements and even avoidedopening them for as long as you could.You've tried to keep the thought ofstocks as far back in your mind as possible,promising yourself that if those 1-time hot stocks in your portfolio evershow any sign of life again, you'll sellthem and put the money permanently ina big, safe cookie jar. Chances are, some of thosestocks are showing sign of life lately, but even if theyaren't, just the spirit of summer may give you theencouragement you need to open those statementsnow and do something about your portfolio.
COUNTING PAPER LOSSES
Most portfolios tend to be full of individualstocks, some holding over 50 stocks, making themessentially impossible to manage for anyone with aday job. What's more, despite holding that manystocks, most of these portfolios are far from beingwell diversified. Most people now know theyshould hold diversified portfolios, but they'refrozen in their tracks because of 2 reasons.
First, they have huge losses in many of thestocks they own, and they somehow want tobelieve that as long as they have not sold thestocks, they really have not lost themoney. They want to believe this is justpaper loss and the stocks will comeback, at least part of the way, but ifthey sell the stocks, they'll likely loseany chance of recouping the losses.Second, they don't know how theywould reinvest the money if they soldthese stocks. Should they put themoney in money market funds, bonds,or utility stocks?
MAKING A CLEAN SWEEP
Start by facing up to the fact thatpaper losses are losses. Although it'spossible that some of those stocks willrecover to some extent, waiting aroundfor that to happen is more risky thanyou think. Remember that if your portfoliowas not well diversified before, it'snot well diversified now. So, you're taking what alot of finance people call diversifiable risk (ie, riskthat you can and should diversify away because themarket does not compensate you with higherreturns for taking such risk).
If you invested $10,000 in a stock and the positionis now worth just $300, you may want to holdonto it as a lottery ticket. But you'll be better offselling most individual stock positions. Don't getinto the ritual of reanalyzing all these stocks andtrying to decide which ones may come back andmay be worth holding onto, and which ones won't.Whatever method you used in the past to makethat judgment didn't work, and odds are, any newmethod you use now won't work either. Trying topick and choose will only delay things, and ultimatelymay prevent you from taking any action.
If you want to look at the bright side—and yes,there is one—you'll be able to carry forward all thecapital losses you realize. If you have huge capitallosses, as most investors do, you may not pay anycapital gains taxes for a long time, if ever. That willgive you greater flexibility in dealing with your taxableportfolio in the future.
REINVESTING YOUR SELLS
Make reinvesting the money from your stockselling a 2-step process. The first step is to decideon the appropriate asset allocation for your portfoliowithout regard to what happened in the past.Think in terms of what you would have done if youwere starting from scratch to create a portfolio inyour current circumstances. Use that as your target,and even if you don't want to get there rightaway, plan to get there soon, taking advantage ofany market upturns.
In step 2, invest the money in a few good, lowcostmutual funds, making sure that you're welldiversified and not concentrating solely on fundsthat have done well in the recent past. Don't picka fund that you think will do well for the next fewyears, but head south after that, forcing you tomake a quick exit from it. Acknowledge the factthat you won't know when to switch out of it.Unless you can see holding a fund for at least thenext 5 years, preferably longer, you shouldn'tinvest in it in the first place. However, with allthose losses in your pocket, you will at least havethe flexibility to switch out of a fund without anytax consequences if necessary.
Chandan Sengupta, author of The Only
Proven Road to Investment Success (John Wiley; 2002), currently teaches finance at the
Fordham University Graduate School of Business and consults with individuals on
financial planning and investment management. He welcomes questions or comments