Do you hold too many Shares? read on

In a bear market the toughest task any investor must face is to answer the question: ‘How much should I have in equities in this market?’ There is no answer that covers everyone but I want to use three examples to at least canvass some of the options. And before we start, last night's trading on Wall Street was typical of a tough market. At one stage the Dow index was up 132 points but then shares ran into a wall of pent-up selling and fell back to negative territory before returning to the positive. The US market is brittle and won't stand a volley of bad news. Events in US and China are still unfolding, so in Australia no one can be certain of the final outcome. But when a market turns bad it usually lasts longer than expected, although it is punctuated by big rallies. Of course, bull markets also usually last longer than expected and also experience serious corrections. The fall in share prices over the past two months has caused all investors to look much more closely at their underlying investment strategies and asset allocations. A lot of people have begun to realise that they have selected a mix of assets that might have looked good in previous years but are now throwing up losses that are causing personal anguish. Others take a different view and some are actually excited by possibility of a period of depressed share prices. I would like to illustrate some of the options using the example of three people I know:
A self-managed superannuation fund investor nearing retirement who did well out of the share market but pumped big sums into his fund last year as part of the special $1 million entry concession launched by former Treasurer Peter Costello.
A young sports medicine professional, having paid for his education was beginning to save a house deposit. He believed the way to get there faster was to leverage a leading share portfolio. After procrastinating for a year he dived in last November near the top of the sharemarket.
The manager of a closed "value" investment fund who is now emerging from two of the most difficult years of his life. The SMSF investorOur self-managed fund investor put 60% or more cent of his fund's money in leading local and international shares and about another 20% in listed property trusts, leaving a bit of cash. It was an aggressive strategy that served him well. He believed property trusts would not fall greatly even in a tough market – the old "bricks and mortar" view. The losses he has incurred are much more than he was mentally prepared for and it's affecting his sleep. His wife is not fully aware of what has happened and he has not told he that he may not retire when they planned. There are countless numbers of people in this situation. I will talk about property in a coming edition, but suffice to say that commercial property can fall dramatically in certain circumstances and those circumstances have recently arisen in the US and the UK. We will get some of the backlash. And private homes – despite assertions to the contrary – are not spared if the economy turns down sharply: Around 1990 in Australia, the value of large expensive houses fell 40%. Investing in listed property trusts is investing in shares, so it's classed as equity. As a result, the investor is invested 80–90% in equity in a bear market and facing losses approaching 20%. The advice that many planners would now give is: “Tough it out and keep investing. Wait a year or two and it will all come around." Long-term that's good advice but the timing is impossible to predict: "a year or two" might not be enough time. It could be less. While the person's fund chalked up big profits in past years the avalanche of money close to the top has been a disaster. For what it’s worth, I think that where the losses are affecting an investor’s personal life, it’s time to face them and adjust the portfolio to a level of equity exposure they can live with. Two-year bank deposits offer annual returns of about 7.5% (twice the rate of inflation) but you have to shop around. They could rise further. Some say the best strategy is to accept the 20% loss and sell all the equity, putting the money on short and long-term deposit until the bear market has passed. The trouble with that strategy is that those that adopted it in the late 1980s usually never returned to the sharemarket because, first they had to be certain that the market had really stopped falling; and then, by the time they were satisfied, they felt they had missed the inevitable upswing. But let’s say our friend moved to 50% equity, including property exposure and 50% bank yield-based investments such as interest-bearing deposits. Many would say that a 50/50 ratio too conservative but serious losses in people's late 50s or 60s can be so stressful as to reduce life expectancy. A rival view is that shares are the best savings mechanism and you should have and 80–90% exposure and ride the ups and downs. That's true over the long term but not everyone has the ability to sleep through the loss periods. The young professionalMy second example, the young professional, tells me he simply forgets his disaster, although when I see him he always asks about the market. With the help of parents, he has cobbled together more money so he can hold the loan-financed portfolio. There have been enormous sums made on borrowing to invest in shares, but I have been through several long nasty bear markets and seen hideous losses from margin investing so I have never been tempted. It's a wonderful game in a bull market but it’s better to do other things when the market turns because a much greater skill level is required. And we have seen some very high-risk takers (like Tricom) play in the market, ignoring the safety rules and paying the price. There are two clear rules from the past when it comes to margin investing.
Never use margin lending to acquire a significant stake (more than 10%) in a company because you may not be able to sell it if the price falls.
Never margin borrow to buy illiquid shares (stocks where there is a low turnover). You may make a fortune but it's a huge risk. The only time when those strategies are appropriate is if you have other assets that can be tapped. A lot of the margin lending deals in recent years were sold like life insurance, or encyclopaedias of old. Lottery tickets would have been a lot safer because with them people recognise the risk and don't over-commit funds. On the other hand, my young professional has time on his side and he will get through this. But unless a young person in that situation finds a rich partner he will be renting for a few more years The value investorMy value investor specialises in small companies and has not done well over the past two years after many years of wonderful returns. He could not find the stocks and made a few big mistakes. Now he is seeing institutions beginning to dump small illiquid investments at any price. That's where fortunes can be made. But we are operating in a period where credit is much tougher so it's very important when selecting small companies to make sure they have plenty of funds and/or a strong cash flow. Those that are running out of cash are going to find it very hard to raise it. The trouble with the small-company market is that it requires a lot of research and only a few brokers undertake it. It also requires a long-term time strategy because it can take years for a stock to perform. The message I deliver is that there is no asset allocation formula that suits everyone. You know you have the wrong one if the losses are getting to you. Make sure you have cash breathing space.