Earning Without Burning

Pity the investor who happens to receive a windfall of cash today--a big company bonus, for example, or a lump-sum pension distribution. Sure, the money’s nice. But what to do with it?

As a long-term investor, you know that the stock market generates the best returns of any financial asset over time.

But after six years of a spectacular bull market in U.S. stocks, you also know your deepest fear: that the market is nearing a major peak, and that if you invest a large sum today you risk being the proverbial last one into the pool--before a harrowing plunge in prices.

Now, there are plenty of academic studies out there that would advise you to simply put that money to work in stocks and forget about it--provided you have at least a 20-year horizon.

A 1995 study by the American Funds group in Los Angeles looked at the growth of a portfolio whose owner had the worst possible timing, year in and year out. This investor put $10,000 into the Standard & Poor’s 500-stock index at its high price each year, for 20 straight years, from 1975 to 1994.

The result: The $200,000 total invested over that period was worth $900,900 by March 1995--great growth, even though the investor bought on the worst (highest-cost) day each year.

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That’s all well and good. But what if you don’t have a 20-year horizon? The history of bull and bear market cycles since the 1930s suggests that you might have good reason to be concerned about buying at what could be a bull market peak. Consider:

* The average bear market since 1933 has slashed 32% from the value of the S&P; 500, according to data from the Society of Asset Allocators and Fund Timers.

In other words, if this is the peak, and a typical bear market is about to begin, you could see nearly a third of whatever you have invested today melt away before stocks would climb again.

* After a bear market begins it can take a long time to get investors back to even. Since 1933, investors who bought the S&P; at its bull-market peak in each cycle had to wait 3.5 years, on average, just to see their nest egg rise back to that peak level--before they even began to see a return in terms of stock price appreciation.

We’re being generous here in excluding from those average-bear-market figures the decline, and subsequent time-to-break-even, that followed the 1929 market crash, history’s worst.

The point is, although stock bear markets often are over quickly, it still can take a significant passage of time for your nest egg to return to what it was at the previous market peak.

Fortunately, if you don’t want to take that kind of risk today, there are several strategies you can employ to potentially lower your risk while still putting money to work--as opposed to just stuffing it in a mattress. Here are some ideas for investors with cash burning a hole in their pockets and fear burning a hole in their stomachs:

* Buy value. Everybody’s talking about “finding value” in the stock market today. But then, what else do you expect portfolio managers to say--that they’re trying to buy the most overpriced stocks they can find?

The real question is, what constitutes true value today? John Laupheimer, manager of the Massachusetts Investors Trust and the subject of an interview that appears on D4 today, sees value in Philip Morris stock [$138.75 on Monday, New York Stock Exchange], which trades for 18 times 1996 earnings per share--arguably cheap for a blue chip.

But given that stock’s 62% rise from its 1996 low, other pros looking for value today would rather buy issues that have either been left behind in the bull market, or have been slammed by sellers down to levels that make them bigger bargains for investors with a long-term view.

Marc Kelly, a principal at Spectrum Asset Management in Newport Beach, advises building portfolios with names like AT&T; [$36.75, NYSE], McDonald’s [$44.875, NYSE] and engineering giant Fluor [$64.50, NYSE]--all of which have been beaten up in recent months because of disappointing earnings projections.

If you want to “buy low and sell high,” Kelly says, you must start with what’s low. “I want to be buying quality, but also something that is certainly cheaper than it was recently,” he says.

Among major industry groups, the stock sectors that have fallen the most over the last 12 months while the broad market has risen include machine tool makers (such as Cincinnati Milacron, [$20.75, NYSE]), broadcasters, gold-mining firms, steel stocks (see story, above), restaurants, truckers and engineering firms, in that order.

More broadly speaking, many smaller stocks have continued to sink since last summer’s market pullback, even as the blue-chip Dow industrials have zoomed. “The whole small-stock area is one I would look at” for value, Kelly says.

Naturally, if you’re buying what’s already down or underappreciated, your hope would be that that investment is already in a bear market--and thus is likely to rebound faster than the high-flying S&P; 500 will, should its next bear market be just around the bend.

But here are two caveats: First, beaten-down stocks often get that way for a good reason. You have to be confident in the business’ long-term prospects before jumping in.

Second, smaller stocks may already be depressed, but they can become much more so, and quickly, before rebounding. In a bear market, “smaller stocks will be buried [initially] because there’s not enough liquidity to support them,” notes Lon Morton, head of Morton Capital Management in Calabasas.

* Buy foreign stocks. Numerous foreign markets have been hitting new highs with the U.S. Dow this year. But you will still hear many investment pros say they’re more comfortable investing new cash in foreign stocks (or foreign stock mutual funds) than U.S. stocks, mainly because foreign bull markets generally haven’t been running for as long, or as powerfully, as the U.S. bull in the 1990s.

The idea here is that foreign markets are still playing catch-up. It’s a reasonable assumption. But as with smaller U.S. stocks, don’t be lulled into thinking that foreign shares won’t dive if U.S. blue chips suddenly plummet. You may be picking up greater values in foreign stocks or foreign funds, but if you buy now you still may need a time horizon of a couple of years to realize a decent return.

* Buy bonds. Yes, bonds are boring. No, they probably won’t give you the returns over the long run that stocks give you. But if you’re trying to invest conservatively today, give bonds some thought.

Why? If you buy individual securities, such as U.S. Treasury notes, you can guarantee yourself a set return each year between now and the time the notes mature. Five-year T-notes, for example, now yield about 6.4%.

Will the stock market beat 6.4% a year over the next five years? Maybe. But if a bear market is looming, remember that average 3.5-year post-bull-market-peak period in which investors have historically earned nothing in price appreciation from stocks.

If that happens again, 6.4% a year in interest might look like a wonderful return.

Kelly says bonds may be the most logical diversification move today for investors who already have lots of stock and now have fresh cash to put to work.

* Dollar-cost-average. Perhaps the best approach to stocks in a pricey market is simply to average your way in: If you’ve got a wad of cash to invest, and you definitely want that money in stocks for the long run, divide the wad into 12 equal pieces and plan to buy into the market each month, on the same day, for the next year.

This takes discipline. But whether the market zooms or tumbles over the next year, you’ll be getting in gradually. It beats the risk of investing a big chunk on a single day that may live on in infamy: the day the great ‘90s bull market peaked.

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What if This Is the Peak?

Terrified of being the last one into the stock market before it plunges? It’s no fun to buy at the top, of course, but history shows that most bear markets, however painful, are relatively short in duration. Still, on average since 1933, it has taken 3.5 years just to get back to even for investors who bought the blue-chip Standard & Poor’s 500 index at each bull market peak.

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Bull market S&P; 500 decline, Years to peak (year) peak to trough break even 1929 --87% 25.2 1933 --34% 2.3 1937 --55% 8.8 1938 --46% 6.4 1946 --28% 4.1 1956 --22% 2.1 1961 --28% 1.8 1966 --22% 1.4 1968 --36% 3.3 1973 --48% 7.6 1980 --27% 2.1 1987 --34% 1.9 1990 --20% 0.6 Average (excluding 1929) --32% 3.5

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Note: Results don’t include dividends. If included, they would make net decline smaller and time to break even shorter.

Source: Society of Asset Allocators and Fund Timers