I'LL SAY THIS

for

Merck

So why did I sell my (thankfully) modest position?

The reason actually has little to do with Vioxx, although it served as a catalyst. Merck wasn't the only health-care stock I sold last Friday. Over the years, I've accumulated a grab bag of pharmaceutical and biotech stocks, so many that I might as well have been running my own little health-care mutual fund. Even before the Vioxx announcement, I'd been questioning this approach. Can I, as an individual investor, really keep up with the fast-moving world of new drugs, clinical trials and generic competition?

The answer, I've concluded, is no. This doesn't mean I've abandoned health care as one of the key thrusts of my investment strategy. Quite the contrary. Although the sector has lagged in recent years, the demographics an aging baby boomer population make for a compelling investment thesis, in my view. Nor do I buy the pessimistic view I've heard from some analysts that scientists have reached an impasse in the search for new cures. I'm confident that new drugs and new therapies will be found. The question is, by whom?

I used to follow a simple contrarian strategy of buying the big pharmaceutical company most out of favor with Wall Street analysts, as long as it had a strong research and development effort. My theory was that these companies are widely followed by analysts, who know the existing drug pipeline inside and out. There's no way to get an "edge" there. So my idea was to buy stock in a company before it announced any research breakthroughs, just when analysts were despairing that any would come. This worked well for many years, and it's the reason I ended up with so many pharmaceutical stocks.

For example, years ago I bought shares of Monsanto, which owned Searle. Searle seemed to have nothing in its pipeline. Then Searle discovered Celebrex, the Vioxx rival. Pharmacia bought Monsanto, in large part to get the rights to Celebrex. Then Pfizer bought Pharmacia. My stock kept climbing, even as it changed names. Without paying much attention, Pfizer grew into my second-largest holding.

My problem has been that I didn't follow through on the second half of my strategy, which should have been to sell when Wall Street analysts decided they loved my stocks. On that basis, I should have sold Pfizer long ago, since Pfizer has become a darling of Wall Street analysts. But I never did.

I've also decided that my old strategy was too simplistic for today's complex world. With new biotech companies springing up all the time, many with single products in development, an investor can't simply pick and choose among the familiar names of the giant pharmaceutical companies. And they've become too big, anyway. How can Pfizer generate anything close to 20% annual gains when its market capitalization is already $231 billion?

Still, it took the Vioxx scare to move me to action. Fortunately these things don't happen often. But who wants to worry about the next blockbuster drug to falter in clinical trials? I'm already reading about new scrutiny for Celebrex. Although it seems perfectly safe, there's no telling how it will fare in further clinical tests. And some doctors are questioning whether any of the drugs in this category are worth the money, considering generic alternatives. I don't want to have to worry about this, or spend my spare time reading FDA reports.

The answer for me is diversification. On Friday I sold most of my pharmaceutical and biotech stocks and put the proceeds into two exchange-traded funds and one mutual fund. For the large-capitalization stocks, I think an index fund is fine. For the smaller biotech companies, active management could lead to higher returns, since the field is less thoroughly covered by analysts at the big firms.

Using tools available on SmartMoney.com, I researched and then bought the Global Healthcare Sector Index Fund and the Nasdaq Biotechnology Index Fund. I also invested in the Jennison Dryden Health Services Fund, despite the typically high fee structure. The fees will be money well spent if the Jennison fund can continue its five-year annualized return of more than 18%. There are plenty of other health-care funds to choose from, including funds that are more specialized in biotechnology and medical equipment.

So now I'm very diversified in the health-care sector, and better insulated from any future shocks like Vioxx. And I haven't entirely abandoned Merck. It's one of the Global Healthcare fund's top-five holdings.