BOSTON — Stocks always rise over the long haul. Bonds are for retirees and investors with little taste for risk. Companies rarely cut their dividends.
Those are three of the long-followed rules of investing – and rules that, as investors learned during a year of the stock market's worst turmoil since the Depression, can't always be counted on.
The new rules: Bonds may be the better long-term bet. Diversifying your portfolio means more than just picking different types of stocks. And nothing, including the humdrum money market fund, is risk-free.
Not even blue chips like Dow Chemical and General Electric, once considered so reliable they were deemed good for "widows and orphans," were safe when everything seemed to be crashing.
At their lowest points over the past year, each stock could be purchased for less than the price of lunch at McDonald's. And each company slashed its sacred dividend – Dow for the first time in 97 years, GE for the first time in 71 years.
As the meltdown helped take out half the stock market's value from its peak, investors and advisers began to question the time-honored strategies of the longest investing binge in American history, dating to the start of a bull market in 1982.
A historic rally over the past six months has restored some wealth and given everyone time to think about what went wrong and what can go right again. What's emerging is not so much rejection of old ideas but an effort to adjust them to fit a more unpredictable market.
"Gone are the days when a 5 percent to 7 percent return is viewed as too small," says Cassandra Toroian, chief investment officer of Bell Rock Capital, a Delaware-based money management firm. "People are willing to take a handful of singles as opposed to trying to get one big home run right now. That mentality will take years to come back."
Here are five examples of how the year after the meltdown has changed the old thinking about investing:
1. ASSET ALLOCATION
CONVENTIONAL WISDOM: Safe investing means adjusting the mix of stocks and bonds in a portfolio based on an investor's age and appetite for risk. Younger investors were advised to own more growth stocks, then transition as they aged into more shares of well-established, blue-chip companies and into bonds, which return less but are less risky. Stocks were expected to beat bonds handily over the long haul.
NEW THINKING: A broad measure of the bond market, the Barclays Capital U.S. Aggregate Bond Index, is up nearly 14 percent since October 2007. That compares with a 28 percent decline for the Standard & Poor's 500 stock index.
Going back five years, to well before the recession, bonds still win. They've returned an average 5 percent a year versus just 1 percent for the S&P 500. And the last 10 years have been a lost decade for stocks. They've had an average annual loss of 0.5 percent compared with an annual gain of 6.2 percent for bonds.
You have to measure back 20 years to find a long-term edge for stocks, and even then it's small.
"It's definitely blown up the view that stocks always outperform over long periods," says Tony Rodriguez, head of fixed-income strategy at First American Funds in Minneapolis.
Investors have taken the hint. They put $209 billion into bond mutual funds through August, 13 times more the amount invested in stock funds, according to Morningstar. Typically, stock funds attract more than twice as much as bonds.
But bonds also may face headwinds in a few years. Deficit spending by the federal government may ignite inflation and drive interest rates higher, which would depress the price of bonds.
"Bonds are about to take a big hit," predicts Dan Deighan of Deighan Financial Advisors, a firm in Melbourne, Fla., that manages more than $150 million for wealthy investors.
2. STOCK DIVERSIFICATION
CONVENTIONAL WISDOM: You should diversify your stock portfolio to protect yourself in bear markets and get the best returns in bull markets. In downturns, count heavily on "value" stocks – those considered cheap compared with historically steady earnings. To take advantage of good times, own more volatile "growth" stocks – those expected to have rapidly growing earnings.
NEW THINKING: The dramatic stock rally since March suggests a slowdown is inevitable and that it's time to move more into value stocks. But a robust economic rebound could reignite the rally, meaning growth stocks would provide the best chance for big returns.
It all depends on what type of economy emerges. Typically, the economy will grow at least for several years after a recession. But this time, Americans are hesitant to spend because of the high unemployment rate and the lasting effects of the housing bust.
A slow economic recovery could send the market into a "W" pattern – big gains followed by a second steep decline.
Compounding the confusion, a large proportion of value stocks are banks, which are still not back to full strength and many of which are still taking losses from declines in commercial real estate.
"What we've experienced with many of the banks is a junk rally – the lower the quality of the stock, and the closer a business got to dying last year, the better it has done since," says Paul Larson, a Morningstar Inc. stock strategist.
Experts say to expect more volatility in the economy – a choppy recovery, not a steady upward climb. That makes any broad bets about which types of stocks that will gain the most in coming months and years an unusually dicey proposition.
3. ALTERNATIVE INVESTMENTS
CONVENTIONAL WISDOM: Keep stocks and bonds as the foundation of your portfolio and put minimal amounts in other types of assets.
NEW THINKING: Put more of your retirement nest egg in tangible assets. Think not only about your home but also about other kinds of real estate, as well as gold bullion, says Deighan, the Florida financial adviser.
"After last fall, people were looking at these standard diversification models, and saying, 'I thought I was well-diversified,'" he says. "Well, according to those computer-driven models, you were. But you really weren't."
Many investors have already turned to gold and real estate as hedges against stock market downturns, higher inflation and a weakening U.S. dollar. Real estate prices in much of the country are perceived as having hit bottom. Gold had a great run over the last year – from about $700 an ounce last fall to more than $1,000 this month.
Mutual funds investing in stocks of companies that mine gold or other precious metals have beaten all other fund categories over the past year, with a nearly 36 percent return, according to Morningstar. Over the past five years, only Latin American stock funds beat precious metals.
CONVENTIONAL WISDOM: Stocks that pay dividends ensure you a steady stream of income.
NEW THINKING: So far this year, companies have cut dividends at a record pace. During the five decades before last fall's meltdown, about 15 companies increased their dividends for every one that cut, according to S&P. So far this year, dividend cuts are running ahead of increases. The total cut so far this year by S&P 500 companies – $47.4 billion – already tops the full-year record of $40.6 billion set last year.
Companies cut dividends because they need to conserve cash. And once a company cuts, it often doesn't restore its dividend to its previous level until it's confident it can afford to give up the cash. And that can take years.
Elaine Durham Mobley, a widow and retired bank accountant, used to receive $5,161 in dividend checks every three months from Bank of America and General Electric. Those checks now total $682. About a third of her $64,000 in annual income has vanished.
"I always thought these dividend stocks were quite safe," says Mobley, 75, of Sautee Nacoochee in the mountains of northern Georgia. "But we have to remember the law: There's nothing sure in life but taxes and death."
CONVENTIONAL WISDOM: Some investments are risk-free. You can put money in them and not worry whether it's safe.
NEW THINKING: There is no such thing as risk-free. At the height of the financial crisis, one large money-market mutual fund, the Reserve Primary Fund, exposed investors to losses because the fund bought debt of Lehman Brothers, which went bankrupt. It was just the second instance of a money fund "breaking the buck," or falling below $1 a share, in the past four decades.
The government rushed in with guarantees for money funds similar to banks' FDIC insurance – guarantees that expired this month. New rules will further restrict the investments money funds can make and lower their risk. But they come at a cost. Money fund are averaging yields of less than one-tenth of 1 percent – barely better than cash.