The first quarter of the new century had investors buckling their seatbelts and longing
for the relative calm of the 20th Century. Overall performance was not bad. The S&P
500 gained 2% for the quarter, although the Dow Jones Industrial Average lost 5%. The
Russell 2000 (an index of small-capitalization stocks) earned 7%. The most volatile sector
of the market was Internet and other technology stocks, best measured by the Nasdaq, which
increased by 12%. However, each of these indexes was
volatile when viewed alone. The Dow was down by 12% for the first two months, then gained
heavily along with the S&P 500. The Nasdaq was up by 13% at the end of February, then
showed tremendous volatility that continued into the first two days of April.
Broad-based international stocks were virtually flat during
the first three months, and showed much less volatility than their U.S. counterparts.
Emerging market equities gained 5%. Once again, international stocks showed some
diversification value during times of high U.S. turbulence (since 1970, every time the
U.S. market has declined by at least 10%, international diversification has reduced
portfolio risk).
Three Lessons to Learn
What lessons can we learn from the past three months? Frankly, three lessons that mPower
has preached since its founding.
First, broad diversification is critical in reducing risk.
Large-company stocks did terribly in January and February, while smaller-company and
high-technology stocks did great. In March, the results completely turned around.
International stocks were relatively stable during all three months. A portfolio comprised
of all three groups would have provided much less gyration than a portfolio of all
large-cap or all technology stocks.
Second (and this is related to the first), no stock market
investment is a sure thing. Many investors felt that tech stocks could only rise. But,
with astronomically high valuations and relatively low current earnings, these were (and
are) very risky investments. Of course, some individual stocks showed even more risk.
Yesterday, in the middle of a downturn of tech stocks, I received an e-mail from a reader.
She told me her "diversification" wasn't working -- all of her stocks were down.
But, as she listed her holdings, it was clear she had locked into mostly high-tech,
smaller companies. The only Dow member in the portfolio was Microsoft, which led the
decline in technology-based companies. Ah...for some financial and industrial stocks to
ease the pain.
Finally, market and sector timing is very risky. In late
February, my weekly
column reminded investors not to invest solely in large-company OR small-company
stocks. Many readers apparently misunderstood me, because they wrote back that they had
mistakenly only held large-caps, but were now redeeming all of those funds and putting all
of their money in small-caps in the Nasdaq -- which was not what I said. (Interestingly,
no one wrote that they had been investing solely in the Nasdaq, but were now selling off
those gains and putting all of their money into large-caps.) Those who invested only in
the Dow in January and February, and only in the Nasdaq in March and early April, would
have lost an aggregate 27% for the year. Ouch!
What Will Happen Now?
What will be happening in the next quarter? More of the same, but with diminishing risks.
During April stock price movement will be based mainly on two factors -- announcements of
first-quarter corporate earnings and expectations about whether the Federal Reserve will
increase interest rates again in early May. As a result, we can expect continued wide
swings in stock values for the next five weeks. However, there will then likely be a
reduction in market volatility.
So what should you do? Remember the lessons. Ignore any
recent losses, ensure you have broad diversification, and maintain consistency. And
remember, even a widely diversified portfolio will occasionally lose value. But, always
keep in mind that you are not investing for next week, next month, or next year. You are
investing for a long retirement.
 Lummer's Logic Archives
Scott L. Lummer, Ph.D., CFA, 401k Forum's Chief Investment
Officer, is a recognized expert in the investment field. He has conducted extensive
research on asset allocation, international investing, risk management, mutual fund
analysis, ethics and valuation, and is a co-author of The Pension Investment Handbook.
|
