Lessons From Investing's Lost Decade

Aug. 2, 2012— -- The 2000s, when the stock market punished many investors with an up-and-down ride that delivered no overall gains, are widely referred to as the lost decade.

The disappointment hasn't ended. "The lost decade is now in its thirteenth year," says Martin J. Pring, co-author of Investing in the Second Lost Decade.

Since 2000, the S&P 500 has registered two plunges of more than 50 percent and several of more than 10 percent, leaving this index slightly lower today than it was 12 years ago. With portfolios (including those held in 401(k) plans) now under fire from the most volatile stock market ever, the current decade holds little promise for improvement over the last.

This isn't your father's market. Gone are the days when using a buy-and-hold strategy – purchasing a variety of stocks and sitting on them long-term – makes sense.

"Buy-and-hold investors have little to show for the roller-coaster ups and downs, aside from a nauseous gut," says Pring, chairman of Pring Turner Capital Group.

That's because a buy-and-hold strategy can easily leave you open to big hits. It's critical to protect your portfolio from such hits because it could well be impossible to recover, especially if you're approaching retirement.

Today's unforgiving market makes it more important than ever to fortify your portfolio against risk. Here are some defensive moves to consider:

Take refuge in cash. By "cash," I don't mean dead presidents but investments that are highly flexible because they can be quickly liquidated without penalties. These include money market funds and extremely short-term Treasury bond funds.

Go light on growth stocks. When the market plunges, stocks of rapidly growing companies often go down disproportionately. Market drops of 10 to 20 percent can drag these growth stocks down 25 to 60 percent. In bear markets, it's not uncommon for them to drop 70 to 80 percent from their highs. When this happens, your portfolio ship's propellers turn into anchors. The moral is that you don't want to be too heavily invested in growth stocks in a severe correction or bear market.

For value investors, begin focusing on quality. Value investing is the practice of buying stocks you believe are undervalued but will eventually rise. In the current market, even the best of these value horses are likely to falter. Instead, look for companies that the market sees as being high quality now.

Quality companies have good balance sheets year after year, and they have lower volatility. Thus, they have good returns for the risk taken. They may not rise meteorically during good markets, but they can serve as safe havens from market storms.

Identify defensive market sectors. Some sectors or industries are inherently defensive. Among these are mature companies including utilities, which aren't race horses in brisk markets but protect capital during tough times because they tend to have stable revenues and predictable costs.

Established pharmaceutical companies with household-name drugs can be protective. So can a category of companies known as consumer staples –for example, Coca-Cola and Johnson & Johnson.

Options. These are contracts that give investors the option, but not the obligation, to buy or sell a security at a set price within a given time period.

A widespread misconception about options is that they are strictly a speculation tool. Yet they are also used to protect against losses.