Beware the Cult

By Daniel Kadlec

If your best friend planned to join a cult and move to a compound in the desert, you'd try to talk him out of it. Right? You'd probably have no luck. Cult members lose their ability to think rationally--an impediment that usually recedes about the time disaster joins the ranks. Way too late. Make no mistake: brainwashed tech-stock lovers are in the same mess, only nobody is trying to talk sense into them. Friends, and Grandma too, have all set up quarters in the same compound.

Last week, though, techies got a glimpse of the smoke and ashes to come. For a few retro days, Dow stocks soared as investors, perhaps sensing an imminent rush to the tech exit, sold all things dotcom. Just about everyone who wanted to got through the door--this time. But if you've made a bundle in NASDAQ stocks and are concerned about their increasing volatility, consider protecting what you've made. Here's how, starting with some basics and moving up the ladder:

--Sell now. Sure, you could miss a move up, and yes, you'll trigger a tax liability. But don't be greedy. If you want to sleep, sell a slug quickly and ratchet down your tech exposure to a comfortable level--30% or so. Too drastic? Consider dollar-cost-averaging out of tech. By selling a set amount each month for, say, 12 months, you'll still benefit from any short-term rallies. The downside: you'll remain vulnerable to a tech sell-off.

--Sell thoughtfully. Hang on to stocks with the most promise, natch. But, fundamentals aside, consider selling stocks held longer than 12 months first. Those incur long-term capital-gains tax, not the more punishing short-term rate. That isn't always best, though. The higher short-term rate may translate into a lower tax bill if gains are modest and the cost basis is high. Consider two stocks: one goes from $10 to $110 in 12 months; the other, from $90 to $110 in six months. You cut your tech exposure by $110 selling either. But the long-term winner triggers $20 in federal tax, based on a 20% capital-gains rate. The other triggers just $7.92 in federal tax, based on the top short-term rate of 39.6%.

--Don't forget your 401(k). View tax-deferred and taxable accounts as one big portfolio. If you can reduce your tech exposure enough just by moving funds in your tax-deferred accounts, you'll avoid taxes and maybe commissions too.

--Sell short. If you can't part with your tech darlings, cut your exposure by shorting the NASDAQ 100 or buying a put option on the index. When you short the index, you borrow a basket of shares and sell, hoping to replace them at a lower price and profit from the decline. A put option gives you the right to sell at a predetermined price, protecting you from a steep drop.

--Put on a collar. Say you own 100 shares of Intel, trading last week at $120. You can buy a January 2001 put option at $110 for $13.50 a share and sell a January 2001 call option at $140 for the same price. Your net cost is zero. Together those options mean that you can sell for $110 no matter how low Intel goes but that you'll never get a dime more than $140. Not a bad insurance policy if you suspect trouble.

Of course, the tech cult won't do any of these things, and may be rewarded for keeping the faith. Amen. I'm not one to quarrel with the brainwashed. But I sure plan to be standing after the disaster.

See time.com/personal for more on tech stocks. E-mail Dan at [email protected] See him Tuesday on CNNfn, 12:45 p.m. E.T.