Buy or sell: How should you react to the bear market?

April 1, 2009

Classifying market movements is easy in hindsight, but how do you know which type of market we are heading into before it happens? The answer is that no one can predict market movements with any consistency.

Q. The stock market has me baffled and depressed. Why don't stockbrokers recommend selling out of stocks when it's obvious we are in a bear market?

In a perfect world, we would time our securities transactions to always buy at the market's lows and sell at its highs, prior to any market correction (routine declines of 5% to 10%) or bear market action. Unfortunately, this requires two near-perfect actions: getting out of the market at the right time and then getting back in at the right time. The scenario usually plays out quite differently, as many investors lose patience, begin to panic, and end up selling at or near the bottom of the market downturn.

Even if investors sell assets prior to the market's decline, they still need to know when it's time to get back in. Since the stock market doesn't go straight up or straight down over time, it can continue to decline after an investor's buying target is reached.

Market declines are inevitable. It's important, however, to have a strategy in place that will minimize the negative impact on your portfolio and possibly even allow you to benefit from a decline in the long run. The global recession could very well keep the stock market in a retreating pattern, but it could also lead to a great buying opportunity by encouraging purchase of shares of stock or mutual funds at lower prices. Even if you don't add to your portfolio during market declines, it's important to refrain from panic selling as you adhere to a long-term investment strategy in an effort to meet your future financial goals.

Q. What should I be aware of before buying municipal bonds?

A. State and local governments issue municipal bonds to finance public projects, such as schools, sewer systems, and roads. Municipal bonds can be categorized as "general obligation" or "revenue" bonds. General obligation bonds are backed by the full faith, credit, and taxing power of the municipality. In contrast, revenue bonds are used to finance tunnels, bridges, hospitals, and other public works, and are backed by the expected income from these projects.

With either type of bond, you as the investor lend money to the municipality, which "promises" to pay you a predetermined amount of interest, typically on a semi-annual basis, plus return your principal to you on a specified maturity date. You can choose to hold the bond until maturity or sell it prior to maturity through the municipal bond marketplace and receive proceeds based on the bond's current value. This is known as "market risk."

As interest rates rise, the value of an existing bond decreases, since it pays a fixed rate of interest lower than what is being offered in the market. On the other hand, bond values appreciate when interest rates decline. This inverse relationship means a bond's market value is dependent on the number of years remaining until maturity. The longer the maturity time frame, the more sensitive the bond will be to interest rates. If market risk is a concern for you, focus on shorter-term bonds that will pay a lower rate of interest.

Keep in mind that municipal bonds are not for everyone, since tax brackets will dictate their effectiveness. Prior to investing in municipal bonds, be sure to gain a thorough understanding of their advantages and disadvantages by speaking with your tax and investment advisers.

Financial Tips

• Stock market fluctuations are impossible to predict consistently.

• The global recession can provide investment opportunities in that stocks and stock mutual funds are available at lower prices.

• General obligation bonds are backed by the full faith, credit, and taxing power of a municipality, whereas revenue bonds are used to finance public works, and are backed by the expected income from these projects.

• As interest rates rise, the value of a bond decreases; when interest rates decline, bond values increase.

Joel M. Blau, CFP, is president and Ronald J. Paprocki, JD, CFP, CHBC, is chief executive officer of MEDIQUS Asset Advisors, Inc. in Chicago. They can be reached at 800-883-8555 or blau@mediqus.com
or paprocki@mediqus.com
.