Diversification Once Again Helps Long-Term Investors Ride Out Bumps
As any calm and patient investor will tell you, last month’s commotion in the stock market was nothing to get agitated about.
Well, maybe just a little agitated. A couple of moments there got pretty dicey--that day in early April when the Nasdaq composite index was down 13% by lunchtime, for one.
And you couldn’t help noticing that technology funds as a group, all of them, fell more than 30% in the few weeks after April Fool’s Day.
But salty long-term investors, especially those who diversify in mutual funds, pride themselves on their ability to ignore the short-term waves and concentrate on the tide. If this makes them seem dull and slow-witted at times, so be it.
You don’t need to step back very far to see their point. Consider the fund performance numbers for the first four months of the year, a period that managed to make room for both a boom and a bust in computer, telecommunications and biotechnology stocks. Net effect: Amazingly little.
Of the 29 categories of funds tracked by the research firm Lipper Inc., only one shows either a gain or loss of more than 10% from Dec. 31 through April 30. That one--down 20%--is gold funds, with the difference now so tiny it almost doesn’t count.
Next you have the always-jumpy emerging markets stock funds, down 9%. Beyond that, nothing else stood more than 8% either way from where it began the year. No, not even those technology funds, which have emerged from all their gyrations with a net gain.
Stretch the measuring tape out further, and the darlings of the bull market still look beautiful. The Bloomberg average of technology funds has gained 95% in the year ended April 30, 59% a year for three years and 38% a year over the last five. A scary spell now and then is a small price to pay for that sort of reward.
“Most technology investors understand that this is a rapidly changing, volatile environment,” says Bruce Bartlett, who manages several funds in the OppenheimerFunds Inc. group.
And what’s the alternative? There doesn’t seem to be any good way to invest in stocks for growth if you’re not ready to withstand shocks--zigs and zags that happen faster than ever, or at least feel as though they do.
Fortunately, there can be some honest-to-goodness benefits for long-term investors from dizzying short-term market swings.
Provided that you do hang in there, interim volatility can work to your mathematical advantage when you follow a program of regular investments toward a long-term goal, often called “dollar cost averaging.”
Suppose you annually invest $10,000 in each of two funds, the Placid Fund and the Frantic Fund, which behave differently as the market rises and falls. Over a three-year period, you buy Placid shares at $10 the first year, $9 the second and $11 the third, and Frantic shares at $10, $8 and $12. Subsequently, the net asset value of both funds rises to $20. To keep the illustration simple, the funds make no distributions.
When you check your statements, you find you own 3,020.2 shares of Placid, worth $60,404, and 3,083.33 shares of Frantic, worth $61,666.60.
Let’s take this up a notch. If Frantic had swung down to $5 and up to $15, you’d now own 3,666.67 shares worth $73,333.40.
Even with that evidence, do you find the ups and downs too nerve-racking? Certainly there’s less volatility if you avoid the technology sector, but should you take that step?
Despite the recent pummeling high-tech stocks have taken, the evidence looks as strong as ever that the Internet is an economic growth powerhouse.
“Over the next five years, the consensus forecast is that tech earnings will rise 25% per year, on average,” says Edward Yardeni, chief economist at Deutsche Bank Securities Inc. “If long-term earnings are on target, then e-economy stocks are not as overvalued as the price-earnings ratios [still above 40 on average] would suggest.”
P/Es over 40, eh? That’s double what is traditionally considered a generous value to put on a company’s earnings. On that basis, the highfliers could easily take another nose dive at any time.
Or if they don’t, they could subject their fans to a much longer period than four months of no net progress, to give earnings more time to try to catch up with the stocks.
That’s why those cloddish, oh-so-boring, long-term investors stay diversified, keeping some of their money staked on technology and some on other, less glamorous stuff.
Stuff like balanced funds, equity income funds, even (gasp!) bond funds, which have been scorned all through the Internet mania.
Lead weights these conservative funds may be, but they served as useful ballast for many a fund investor’s portfolio.
We never know what comes next, but unlike some day traders, momentum riders and margin-debt players, millions of buy-and-hold dullards with diversified fund investments will be around to find out.
