Small investors' guide to market's wild ride

The stock markets may be in turmoil, but small investors don't need to be.

Financial experts say Americans — whose market exposure is mainly through their IRAs and 401(k)s — should stay calm and not overreact to the volatility on Wall Street.

Since the Dow industrial average closed July 19 at a record 14,000.41, it has fallen 761 points, or 5.4 percent.

On Thursday and Friday, the Federal Reserve intervened — something it last did after the Sept. 11, 2001, attacks.

Here's a look at what's been happening, and what a small investor should consider:

Q: Earlier this summer, the market was setting records. What happened?

A: Mortgage lenders got really creative about finding ways to lend money to homebuyers, and pretty sloppy about whom they lent it to. Big investors bought up these shakier loans and pocketed higher risk-related returns.

But fortunes turned, as scores of subprime mortgage lenders either cut back or went broke as borrowers began to default. That spooked investors.

Last week Wall Street powerhouse Bear Stearns admitted it had hedge funds with subprime mortgage problems. On Thursday, France's largest publicly traded bank, BNP Paribas, froze funds that invested in the loans because it said it could no longer measure their value. That sent the market to its second-biggest loss of the year.

Q: So what did the Fed do?

A: The Dow was down about 200 points until the Federal Reserve and other central banks calmed things. The Fed made a huge infusion of cash — $38 billion on Friday, enough to fill a tennis court 20 feet high with $20 bills — to credit markets that lacked liquid cash.

When the dust settled, the Dow closed Friday at 13,239.54, down a mere 31.14. It was a welcome relief after a stretch in which 11 of 17 trading days saw triple-digit moves.

The Fed followed similar moves by the European, Japanese and Australian central banks, which pumped $96 billion into their systems, signaling broad concern.

And all of that's on top of a $130 billion infusion from the European bank and $24 billion from the Fed on Thursday.

"I think the turbulence in the markets will remain because there's concern of the unknown," said Amit Kara, a European financial analyst with UBS in London. "Institutions are holding on to contaminated subprime debt, and we don't know how widespread that is. So until that story unwinds, the jitters will remain.

"Risk is being held by a vast range of institutions. Some see this as a positive because risk is being spread across many institutions. The downside, however, is no one knows who's holding what amount."

Q: Is there a silver lining?

A: Despite the white-knuckle ride, the Dow still stands more than 6 percent higher than when the year began. The S&P 500 and Nasdaq indexes also remained in positive territory.

Q: How does this downturn compare to others?

A: Downturns such as the one we've had "are normal, robust and healthy, but they tend not to be that orderly," said Jim Keegan, a senior portfolio manager at American Century Investments in Kansas City.

Notably, this drop doesn't even rate yet as a full market correction, which by Wall Street's yardstick means a 10 percent drop in major indexes.

And since 2003, there have been at least four corrections, ranging between 7.5 percent and 8.3 percent.

Not to mention 2000 and 2001, when the air went out of the technology bubble. High-flying tech stocks crashed to Earth, costing large and small investors billions. In 1998, the markets went into a panic over a Russian debt crisis and implosion of the hedge fund Long-Term Capital Management.

Q: What does turmoil in the housing industry mean for my mortgage?

A: Nothing if you have a fixed-rate mortgage or a variable-rate mortgage that's within your ability to continue paying easily, said Rocky Shanahan, of Union Mortgage in Kansas City.

But, if you have an adjustable-rate mortgage that's about to reset higher, watch out.

You also can pretty much forget about those no-money-down, 100 percent mortgages that lenders wrote not long ago.

Q: As a small investor, where's the safest place to put my money now?

A: The quick answer is "cash, or very high-quality short-term fixed-income securities," said American Century's Keegan.

But he and others urge investors not to panic. Hastily breaking up a well-diversified portfolio is still apt to do more long-term harm than riding out the storm.

"The best move right now is to do nothing," said Liz Ann Sonders, chief strategist for the brokerage Charles Schwab. "Individual investors should step back until things settle down."

Paul Santucci, an adviser with Ameriprise Financial in Rye Brook, N.Y., said well-diversified investors "should not react to short-term events because you generally make decisions that hurt you in the long run."

For example, he said, an investor who panicked in February when China's market took a dive and pulled money out of the also-slumping U.S. stock market "would have missed a phenomenal increase from that time forward" as the Dow hit 14,000.

Q: So, do nothing?

A: Actually, the market could be a bargain-hunters' paradise for quality stocks and funds with beaten-down prices.

"Instead of lamenting that the value has gone down, you should get excited that your next paycheck lets you buy in at lower prices," said financial planner Ric Edelman of Fairfax, Va. "When the market drops, everything is on sale — and that makes it more desirable, not less desirable, to contribute money."

Q: At the very least, it's a good time to review the portfolio, right?

A: Edelman said a volatile market "should be an incentive, if you haven't done it, to assess the nature of your investments."

Investors who want to tinker with their holdings might consider limiting exposure to financial firms, such as banks and brokerages, which are likely to bear the brunt of the mortgage fallout, and move to industrial companies that should be buoyed by the expanding global economy as well as health and telecommunications, which appear to be holding up well, said economist Ed Yardeni, president of Yardeni Research in Great Neck, N.Y.

Those who are well-diversified, Edelman said, with an investment horizon of at least five years, "can relax, knowing that this will pass."

Material from The Kansas City Star, The Associated Press, The Washington Post and McClatchy Newspapers was used in this report.