| I always wanted to be a circus performer. In fact, I've
watched with envy as my two children swung on a trapeze. Unfortunately, I have a physical
condition that prevents me from engaging in such activity — it's called cowardice. This week I will perform the death-defying feat of answering three
e-mails simultaneously. Please hold your applause until the end, as concentration is
vital.
The first question:
I'm heavily invested in two NASDAQ funds but also have
some money in two large-cap funds. I can live with the volatility (of the NASDAQ funds),
and the risk excites me because of the possibility of excellent returns. My horizon is 10
to 15 years. Am I kidding myself? I'm willing to stay this course and get more
conservative at the end of the race.
And number two:
I hold some shares of a banking stock that is listed on
the NASDAQ. Yet, the behavior of this stock is somewhat opposite to NASDAQ's. Why?
And finally, the third:
With all the wild fluctuations in the stock market now,
what arguments could I use to convince my employees that they should buy into our 401(k)
program and sign up now? Would you recommend increasing my contribution or should I hold
tight for now and wait for a better market?
The "Best" Market
One should always wait to invest in the best market
possible. The problem is, no one really knows when that best market will be. Many
investors were convinced that it had arrived early this year, when the Dow Jones
Industrial Average and NASDAQ were at record highs coming off an impressive five-year run
of strong returns. In a matter of weeks, they were proven wrong. In early 1994, I spoke at
a conference of brokers, and one gentleman criticized me for suggesting investors put
money in stocks during such a bad market — the Dow was at 3,500 then.
Because we really don't know when a better market will be,
I always advise to never put off until tomorrow what you can do today (my wife always
laughs when I say that). Develop a plan for your investing future — read A Simple
Plan for a straightforward approach — and start implementing that plan now.
How Much Should You Invest?
If you can increase your contribution to your 401(k), you
should. You can use retirement calculators to estimate how much you need to invest to
reach your goal. But, all retirement calculators make simplifying assumptions that may or
may not come true. The only true certainty is that the more you invest, the more you will
have in retirement and the higher the likelihood that you will reach your goal.
No Guts, No NASDAQ
Now, as far as where you should invest, the asker of the
first question has the right philosophy but perhaps the wrong tactics. If you have a long
time horizon, as most of you do, you should be willing to accept risk. But, accepting risk
in your portfolio does not guarantee superior returns. For example, shares of a single
stock (with average risk) will be about three times as volatile as a portfolio of stocks
with similar risk. Yet, the anticipated return of the single stock and the portfolio will
be the same.
Yes, the NASDAQ definitely has more risk than the average
portfolio of stocks from the S&P 500. The reason is that the NASDAQ has
disproportionately more small-company stocks and high-tech stocks, which are more volatile
than most other securities. The NASDAQ has other types of stocks, such as the banking
stock mentioned above, but just because a stock is listed on the NASDAQ doesn't mean it
will act like other NASDAQ stocks.
And that's good. The fact that there are financial stocks,
energy stocks, and health care stocks in the NASDAQ holds down the volatility. If it
contained only tech stocks, the NASDAQ would be even more risky than it is already.
However, even with these diversifying stocks, the NASDAQ is
still volatile. And that is why it is too risky to put a majority of your 401(k) money in
the NASDAQ. It's reasonable to hold up to 25 percent of your money in
smaller-capitalization stocks, like the ones that dominate the NASDAQ, but a much larger
portion than that adds too much risk relative to the potential extra return you might
earn.
So, there it is — I hope you liked the show. In a
future column, I hope to juggle 11 asset classes while standing on one foot. |
