March 31, 2001

It's official-the bear market has begun. The bear market is defined as a drop of 20% from a closing high. Technology funds lost 62.20% in the last twelve months alone. Even overseas positions provided no relief. They were down 27.90% for the year. The Dow Jones Industrial Average was down 8.07%. The Dow Jones Industrial Average, whose 30 component stocks are selected by the editors of the Wall Street Journal, went through a change on November 1, 1999. Four new stocks, Microsoft, Intel, Home Depot, and SBC Communications replaced four underachievers (at that time)-Chevron, Goodyear Tire, and Sears Roebuck, and Dow Chemical. These new stocks have fared worst than the four stocks of the past. Basically they removed some large old economy stocks with new economy tech-heavy stocks. The Journal defended the move by saying that the DJIA is intended as a group to reflect the market and the economy. The result is that we will see a Dow that moves in relation to the NASDAQ.

What's the message here? The hardest hit investors have been those who pooh-poohed diversification and loaded up on technology stocks, only to see their portfolio decimated by NASDAQ's plunge. Diversification is not just a defense against market downturns it can also boost returns.

Suppose you held a portfolio that was one-third large stocks, one-third small stock and one-third foreign stocks. At the end of each year, you rebalanced to get back to these portfolio targets. According to Ibbottson Associates, over the past 30 years, your portfolio would have gained 14.20% a year before taxes and trading costs, compared with 13.70% if you had never rebalanced.

History has shown market declines are inevitable (and, in fact normal), occurring every 3 to 6 years. However, if you believe in the long-term upward trend of the markets, history has also shown the best strategy has been to weather the short-term declines. Over the years, the markets tend to take two steps forward, then one step back. Staying the course, along with diversification, realistic expectations and a long-term perspective continue to be the keys for successful investing through up, down, and volatile markets.

Here's a great example from Prof. Thaler of the University of Chicago. What if I asked you to flip a coin and receive $100 from me if you call heads/tails correctly, but pay you $75 if you were incorrect? Mathematically this is a good bet for you, but most people won't take it because they experience more pain from losing than they get pleasure from winning. Now what if I asked you to agree to the proposal if you could flip the coin 100 times? Now most people will take the offer because they understand that the odds are in their favor and they are likely to come out very well if they can play the game over and over. This is how investing works. You don't win on every flip, but over time the odds will work in your favor since historically the stock markets goes up roughly two-thirds of the time.

Peace of mind still ranks as the best investment of all. You may have come to the conclusion that when it comes to declines, your financial ability to tolerate them is of little comfort. In that case, emotional stability is much more important than financial stability and you may want to adjust the portfolio toward the lower risk/ lower return part of the investment spectrum. If no change is warranted, you are then free to focus on the next 100% gain rather than the next 20% loss. How do I judge investment success? By the state of your overall wealth and progress made toward your goals. That's a tall order in a society that focuses on looking at each investment as a "winner" or "loser", using very short time frames in judging investment success, being overconfident in their abilities to make good investment decisions, and feeling the pain of loss about twice as much as they experience the pleasure of gain.

The driver in this bear market- the Federal Reserve. The Fed is not eager to stand by as the economy worsens. However, the effect of rate cuts take time to feel its full impact. Going back to 1914, the DJIA has historically jumped 20% on the average in the 12 months following a rate cut.

Get ready for refi hell. We all have our horror stories (even myself) about the difficulties in refinancing loans with an industry that is based on commission and non-disclosure. But we learn from our mistakes. Please send or email me with your contributions of what you did right or what you did wrong to refinance your loans. I will post them (anonymously) on my website along with my recommendations of what to ask and documents to seek in your quest for the best loan.

My website is up and operational. You can access your statements from my website, but you must first call Schwab (800-865-3864) and get a password to do this.

- Fern Alix LaRocca CFP® EA