Grow Up To 1,000% Richer In The Great Stock Panic Of 2002

Chapter 21

Urgent: Get To Safety Immediately!

We are back to the present and it's time to prepare for the Great Stock Panic. There is much to do, and not much time to do it. First and foremost is to move to safe harbors. Start by making a complete list of all your assets and clean house by selling off all your investments that are vulnerable to sharp declines in value. Here are the steps I recommend:

Step 1. Sell off most or all of your common stocks and mutual funds: Over half of American families are loaded up on stocks, either directly in a brokerage account or through their mutual funds, more than twice the level of previous eras. Yet, virtually none have experience with large market declines. So they have no clue how a bear market in stocks can devastate their net worth.

If you have read this far, you're different. You have a vision of what the future could bring, and even though you probably will not get all-time peak prices, you can still save yourself a lot of money and headache if you liquidate your stocks now, before the real panic begins.

The safest and easiest way to profit from the panic is simply to sell all or most of your stocks now, put the proceeds in Treasury bills or equivalent, and sit it out.

You profit in two ways: First, your cash will be earning good, steady interest. But even more importantly, the value of your cash, in terms of the number of shares it can buy, will be going up dramatically.

For example, let's say you own 100 shares of the ABC stock at $100 per share and you sell it now for $10,000. And let's say it falls to $50 per share. If you measure your wealth in terms of dollars, very little has changed. You still have $10,000 in your account, plus some interest. But if you measure your wealth in terms of ABC shares, your portfolio is now worth 200 shares. And if the stock market as a whole has fallen 50%, you've effectively doubled your wealth � just by sitting in cash.
  • Start by compiling a complete list of all the stocks and mutual funds you currently own. You may own these directly in an account you control, or through a trust or pension fund which you may or may not control.

  • Begin selling off your stocks, starting with those receiving the worst Weiss Risk Ratings. For a list of the 6,000+ stocks we rate, see our report, Weiss Risk Ratings for Your Stocks & Mutual Funds, available gratis to two-year subscribers to the Safe Money Report. Or check the Risk Ratings of your stocks at Most of your stocks are probably actively traded companies and can be sold "at the market" without hesitation.

  • For small or illiquid stocks that do not trade actively, instruct your broker to sell on rallies with a "limit order." We cannot tell you exactly what price limit to set for your stock sales, but in normal markets, 2% or 3% above the current price is reasonable.
Warning: If your stock is falling, or has just fallen dramatically in value, do not assume it's "too cheap to sell."

A stock that has suffered a fall of 50% from, say $100 to $50 per share, can easily suffer another fall of 50%, to $25 per share, and still another 50% fall, to $12.50 per share. So you should not let that stop you from selling.

As to the timing, however, it is usually not a good idea to liquidate all your shares immediately after a major decline.

My advice: Each situation is different. But if your stock is now in the midst of � or has just completed � a nosedive, it's usually best to: (1) Sell half now to reduce your exposure, and (2) hold the balance to sell on the next good rebound. What's a "good rebound"? When the share price recoups from 20% to 50% of its most recent decline.

Step 2. Protect your 401(k) or similar retirement plan:
In a money panic, the 401(k) funds of over 40 million Americans are at serious risk. Two basic principles to adhere to:

1. Don't pull the money out of your 401(k). Even if the investment options in your 401k plan are limited, most do offer alternatives that are a lot safer than the stock market.

2. Within your 401(k) or similar retirement plan, favor safety above yield � choose the safest option available to you. If your plan offers you the option of a Treasury-only money fund, that's ideal. If not, any money market fund is acceptable at this time. And if no money funds are available, a bond fund is almost always safer than stock funds.

For a Risk Rating of the fund choices available to you, see our report, Weiss Risk Ratings for Your Stocks & Mutual Funds. Or visit (Note: There is a nominal charge per rating on this site.)

What if your 401k plan doesn't offer any safe alternatives? My advice: Petition your employers. Let them know that you want a plan that offers more options. You can go to your employer and politely say, "Our 401k plan has only a few options, and they're all invested in the stock market. We need a safer fund in the mix for people who want to be out of stocks entirely." Remind them that under ERISA Section 404(c), retirement plans must offer at least three choices among diversified groups of investments.

If you do not get prompt satisfaction � or until you do � hedge against your retirement funds with the Weiss Windfall Strategy. This is not a conservative strategy, but if your funds are stuck in stocks or a stock mutual fund, this speculative strategy may be able to help protect you against a decline. See our report, the Weiss Windfall Strategy, free for two-year subscribers. Or for a summary, visit our website,

Step 3. Avoid illiquid investments. These include all investments that are hard to find buyers for, as well as those that lock you in with up-front commissions, sales loads, cancellation fees, surrender penalties, early-withdrawal charges, or other fees.

The key to successful investing during a crash, recession, money panic, or any kind of financial turmoil is flexibility � the ability to access your funds immediately, change your mind whenever you want to, and switch to safer or more profitable areas.

For that, your investment must be liquid. It shouldn't take you any time whatsoever to get your money out. Nor should it cost you anything other than a minimal transaction fee.

Here are some illiquid investments to avoid, regardless of their relative safety or performance.
  • Mutual funds that charge you a "front end load" � an up-front sales commission. Commission-based financial planners and brokers love to sell these, but there are thousands of no-load funds available that provide the same service and benefits. And numerous studies prove that their average performance is no different than the average performance of load funds. So why lock yourself in to a mutual fund family with a sales commission when you can have the freedom to allocate your funds to a wide variety of funds?

  • Annuities and whole life insurance policies that charge big sales charges or surrender (cancellation) penalties. Insurance agents will tell you that the insurance company pays his sales commissions � not you. Technically, that's true. The insurance company writes the check � but with your money. Some fees are inevitable in almost all policies. But favor those that are among the lowest. And no matter what, make sure you invest with a safe insurer � with a Weiss Rating of B+ or better. For our latest rating on your insurer or the latest list of the weakest insurers in America, go to

  • Similar investment plans or programs that charge large entrance or cancellation fees. Examples: Privately managed programs.

  • Investments that are very thinly traded in the market � where there are few active buyers or sellers. Small cap stocks, limited partnerships, unrated bonds or private placements; bonds issued by small local governments, banks or other corporations; plus most rare coins, antiques and other collectibles.

  • Real estate. There are some rare exceptions, but as a rule, real estate is far less liquid than stocks and bonds.

  • Long-term bank CDs. Although this is considered a form of cash (defined as a liquid investment), if you have to pay a stiff interest penalty, and the maturity is over a year away, it's not nearly liquid enough in the context of a fast-moving money panic.

Examples of investments
that are typically liquid:

  • A money market fund. Your money is available to you within 24 hours or less. There is almost never a problem. However, if the money fund does not invest purely in Treasury securities, there is a small risk, which could be magnified in a money panic.

    For example, in 1999, even without a panic, large money market funds like the Schwab Value Advantage, Centennial Money Market Trust, and the prestigious Alliance Capital Reserves came close to seeing their net asset values fall below $1 per share. They had invested their customers' monies in obscure derivative financial instruments backed by a little-known insurance company that failed. Over 30 major money market funds were on the hook for nearly $5 billion! So I recommend you favor money funds that invest strictly in US Treasury securities or equivalent.

  • US Treasury securities. The market for Treasuries is one of the largest financial markets in the world. So there is almost always a willing buyer, especially for the shorter term maturities.

    The longer the term, however, the greater the risk of suffering a loss in your principal if you sell before maturity, especially in periods of rising interest rates. Therefore, if maximum safety and liquidity is your goal � and it should be in preparation for a money panic � I recommend you put the bulk of your keep-safe funds in 3-month US Treasury bills or equivalent money funds.

    Note: You can save broker commissions or fees by buying directly from the US Treasury Department, but they are a bit less liquid when bought that way. If you want to sell them before maturity, you cannot do so readily. You would first have to transfer them to a broker or bank, a process that could take a couple of weeks. So for more immediate liquidity, I recommend buying them through a Treasury-only money fund or through your broker.

  • Large cap stocks. These are liquid � you can sell them at almost any time. But that doesn't necessarily mean they are safe; their price can still decline sharply. And in a stock market panic, when floor traders are bombarded with an overwhelming amount of sell orders, even some of the larger stocks could encounter liquidity problems.

  • No-load mutual funds. You can sell without being charged an exit fee. But bear in mind two dangers: First, their share value will decline just as quickly as the stocks they own in their portfolio. Second, with almost all funds, the price you get will be the average price at the close of trading. But as we've seen in recent years, a lot can happen between the time you decide to sell and the end of the day ... and markets are bound to be even more volatile during a money panic.
My advice: Right now, favor US Treasuries or equivalent and avoid investments with low liquidity. Later, when the Money Panic is mostly behind us, consider other liquid investments, but continue to avoid investments that compromise your flexibility.

If you already own an investment that involves heavy exit fees, then you need to weigh carefully the cost of leaving versus the risk of staying.

To help you make that decision, evaluate its risk by using our Weiss Risk Ratings for stocks and mutual funds ( and our Weiss Safety Ratings for financial institutions (

Step 4. Liquidate all but the very best corporate bonds: In 1999, 99 US corporations defaulted on $23.5 billion of debt. That's the largest number of defaults and the biggest losses since 1991. Back then, it was expected � the country was in a recession. But in the late 1990s, it was unexpected and raised the question: If this is what's happening in good times, what's going to befall these bonds in bad times? Why are defaults so high? Many companies that have taken on debt are finding that their profits aren't up to expectations, so they can't make the payments.

My advice: Sell all bonds that (a) do not have a Moody's rating of A or better, or (b) are long term. I don't include any corporate bonds in my "Mr. Conservative" portfolio (page 4 of Safe Money Report). But if you insist on keeping some of your favorite corporate bonds, I recommend you hold strictly A, Aa, or Aaa notes and bonds with less than five years in remaining maturity. Before and during a money panic, the shorter the maturity and the higher the rating, the better.

And by all means, get out of junk bonds. Yes, when yields on other conservative investments (like Treasuries) are very low, these higher yielding bonds can be tempting, and brokers love to push them. But watch out. The yield advantages can easily be wiped out by just one default on the banks you own.

The official definition of junk: Any bond with a rating of double-B or lower ("BB" on the S&P; scale; "Ba" on the Moody's scale).

Problem: The rating agencies may often be slow to downgrade companies despite known problems, and they're typically late in recognizing new dangers in the economy.

I repeat: The higher yields of these low-quality bonds are tempting. But they're simply not worth the risk. Indeed, in 2000 defaults on junk bonds were at their highest levels since 1991; and that was taking place in supposedly "good times." What's going to happen as the economy turns down, or worse, when the Money Panic strikes? Hundreds of bond issuers will default on payments. Thousands more could be downgraded to junk bond levels.

Step 5. Steer clear of most convertible bonds, too. On the surface, convertibles may seem attractive. They pay you a fixed rate of interest income. And, at the same time, they give you the option to convert the bonds into company stock at a certain price.

A "can't lose" investment? Not quite. Buying convertible bonds before or during the Money Panic is wrought with risk:

First, if interest rates spike upward in a money panic, they will drive all bond prices lower. Second, stock prices have a long way to go on the downside. So, there's no gain whatsoever to be made if the stock price falls.

And, remember: The option to convert to stocks doesn't come for free. With convertibles, you do pay a hidden price for it � through reduced yields.

Last, in a money panic, hundreds of companies will see their credit ratings slide. That means even more losses for corporate bonds, including convertibles.

Step 6. Reduce your exposure to a real estate bust. As the stock market falls, the "wealth effect" � the paper profits so many Americans have enjoyed for so long during this bull market � vanishes like a dream. In response, consumers are reining in their spending, causing our economy to slow. And that hits real estate prices hard.

First and foremost, dump any Real Estate Investment Trusts (REITs) you may own.

Second, unload unneeded commercial property. As the economy sinks, vacancy rates are bound to jump. Positive cash flows could easily turn negative.

Third, if you've been wanting to move anyway, sell your home. It's usually not wise to sell if it's going to disrupt your life. But if you've been contemplating a change for other reasons anyway, this is the time to do it.

Step 7. Batten down the hatches in your business. You probably know more about your business than anyone. But as a rule, few businesses can claim to be recession-proof and even fewer will avoid the impact of a money panic. Here's what I suggest:

First, speed up your accounts receivable processing; start collecting payments before your customers run out of cash.

Second, check the credit terms that your company offers. You cannot be too generous anymore.

Third, watch your profit margins. Now's a good time to clamp down on unnecessary expenses.

Fourth, and most important, reduce debt and build cash.

Step 8. Reduce your dependence on debt. With every major sector of the US economy leveraged to the hilt and up to its ears in debt, now is the time to make absolutely sure you are as financially liquid and safe as possible. The Great Stock Panic will bring a flood of personal and corporate bankruptcies� and I don't want you to be among the casualties. Here's what to do:
  • Reduce credit card debt as much as possible. If you can't pay it off entirely, try adding a few dollars extra each month toward the balance. You'll be amazed at how fast this will reduce the amount of your existing debt � and how much you will save on interest costs.

  • Avoid buying stocks on margin. The market swings are too wild. All it takes is a quick downturn and you could be facing immediate margin calls from your broker. The only exception would be the speculative recommendations we make in "Mr. Speculator" (see page 5 of the Safe Money Report). But even there, take extra caution by always using the protective stops we recommend.

  • Don't leverage your home. If you're going to take out a loan against your home's equity to build another room, a remodeling project, or something that will increase the salability and the value of your home, that's one thing. But avoid taking out a home equity loan to invest in the stock market.

  • Don't borrow against your retirement funds. That's one of the worst things you can do. Your retirement account should be considered taboo � don't touch it unless it's a dire emergency.
Step 9. If maximum safety is your goal (and it should be!), avoid Fannie Mae, Freddie Mac, and Sallie Mae Bonds. The Federal National Mortgage Association (FNMA or "Fannie Mae"), the Federal Home Loan Mortgage Corp. (FHLMC or "Freddie Mac"), and the Student Loan Marketing Association (SLMA or "Sallie Mae") offer better yields than US Treasury bonds of the same maturity. So should you buy them instead? I don't recommend it. Indeed, these bonds offer more yield for a reason: They involve more risk. Specifically ...
  • They are not guaranteed by the full faith and credit of the US government. These are private enterprises that are merely "sponsored" by the US government. In a money panic, owners of securities issued by the US Treasury Department will be first in line. Owners of government agency securities (such as those issued by Ginnie Mae) will be second in line. And if you own Fannie Mae, Freddie Mac or Sallie Mae bonds, you'll be a distant third.

  • These government-sponsored enterprises have racked up huge debts over the past few years, making their bonds (or shares) riskier than ever. The last I checked, Fannie Mae had over $700 billion in debt, nearly $37 of debt for every $1 of shareholder equity. Plus, the agency had only $824 million in cash and equivalent on hand to pay $337 billion of current liabilities (debts due in less than 12 months).

    Freddie Mac's balance sheet was even weaker: Only $31 million in cash and equivalents to pay $197 billion in current liabilities. Total debt including long-term liabilities: $378 billion.

    Meanwhile, Sallie Mae had $39 billion in debt � $33 billion of which is due in less than one year. Worse, it has only $106 million in cash on hand ... or less than 4 cents on the dollar to service that debt.

  • Due to these mounting debts, several members of Congress have lobbied to enact legislation that would sever the link between the government and these agencies. It has not become law, but in a money panic, pressures could build for passage of this kind of legislation. In that scenario, the prices of bonds issued by these agencies would plunge in value as the last remnants of government support are jettisoned. Indeed, without the implied government backing, these bonds would be no safer than any corporate bond, and many would get the same ratings as junk bonds. Steer clear.
Step 10. Also avoid other so-called "conservative" investments that may harbor hidden risks. Some prime examples:
  • Foreign-currency-denominated bank deposits, money markets, or stocks. During much of the money panic, we expect the dollar to fall, while the relative value of foreign currencies rises. But once the crisis peaks and begins to subside, the dollar will rally sharply as foreign currencies tumble. So unless you are a nimble trader or are using limited risk options, foreign currency investments are probably not for you.

  • Inflation-indexed bonds. They fail to offer inflation protection against certain key costs, such as college tuition. And the interest is fully taxable at the federal level. If you redeem an inflation-indexed savings bond within the first 5 years, you automatically forfeit 3 months of interest. Most important, their value is likely to fall along with that of other bond prices when interest rates rise.

  • Most municipal and other tax-free bonds. Tax-free income is great. But don't ignore the disadvantages of most tax-free bonds: When rates rise, they tend to fall faster than the equivalent Treasury note or bond. Reason: Even the best-rated munis are not considered as creditworthy as Treasuries. Further, the cost to buy and sell municipals is still exorbitant. When you buy even the best triple-A rated munis, you can pay up to 3% or more. A similar cost can be incurred when you sell.

    Bottom line: The time to buy munis is when short-term interest rates skyrocket and these bonds become dirt cheap compared to Treasuries, giving you a substantially higher yield advantage. But that hasn't happened yet. When it does, I'll let you know in my Safe Money Report.

  • Preferred stocks. In 1929 and 1946, some of the biggest companies saw their preferred shares shed as much as 73% and 56%, respectively. That's a bit less than common shares, but not a lot less.

  • Utility shares are said to be conservative investments. But they have been pummeled in every bear market of this century: In 1929, they lost an average of 76%. In the 1930s, as you saw in Dad's chapters, while industrial stocks were recovering, the utilities were still falling. In the 1946 bear market, utilities lost an average 20% of their value. In 1964-69, they lost 25%; and in the 1972-74 period, utilities shed 23%.

    Average loss in this century's bear markets: A steep 36%! And Wall Street calls that "safe, defensive investing"?! Don't be swayed by attractive dividends or by the old chant of Wall Street that utilities are "great to own in a weak market." It's simply not supported by the facts.

  • Viatical investments. If your local paper is anything like mine, you've been bombarded with glitzy ads promising you "guaranteed returns of 18%, 24%, even 60% or more" in these investments.

    Typically, when you invest in a viatical, you are buying out the life insurance benefits from a terminally-ill policyholder, such as an AIDS patient. The patient gets immediate cash to cover his living and health expenses; and you get the pay-off when he dies. The difference between the purchase price and the proceeds is the profit to the investor.

    Problems: First, despite claims to the contrary, viatical investments are not guaranteed. If the insurance company underwriting the investment goes bust, so could your investment.

    Second, one would hope that the terminally-ill patient can extend his life expectancy as much as possible; and to the degree that he's successful, your yield will plunge.

    Third, there's no federal agency regulating the viatical industry, and virtually no licensing requirements for any of the operators within the industry. Contracts and funds are often held in trusts, lawyers' escrow accounts and the like; and cracks can develop in any one of the links between the investor and the insurance company actually offering the viatical settlement.

    My view: They're risky in normal times. They will be even more risky in the Great Stock Panic.

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