Years back I was given some simple, straight forward advice about investing. What I was told was that if I steadily invested a part of my earnings into a diversified stock portfolio that over time my capital would grow. I was also told that at least once each year I should re-balance my portfolio to maintain a consistent mix of assets, thereby preserving my level of diversification which was the safety net upon which I was to rely. I was cautioned that there would be good years and there would be bad years but that if maintained this buy-and-hold discipline and asset diversification that over time I would come out ahead.
That advice was given to me back in the early to mid-1980′s, a few years before the October 1987 market crash. I learned something from that crash. When the broad market declines, so does a diversified portfolio. Back then I was young man and I had decades of saving and investing ahead of me, so my level of concern was rather low. My parents, on the other hand, were affected a bit more severely than me since they had watched their retirement accounts take quite a bruising and their timeline was considerably shorter than mine.
As bad as the 1987 crash was, It all worked out because the market soon bottomed and a new bull market soon emerged. The crushing losses were soon forgotten as investment accounts once again began to see growth. Unfortunately, the lessons taught by that crash were also soon forgotten.
By the late 1990′s the ’87 crash felt almost as remote as the ’29 market crash. The bull sentiment grew to euphoric levels prompting the then Federal Reserve Chairman, Alan Greenspan to express dismay about the apparently “irrational exuberance” of investors. It was a new era, though. The Internet had arrived and new Internet business models were going to transform business. Baby Boomers were pushing toward retirement and all those 401K dollars were going to maintain the buoyancy of this market.
The mutual fund industry was booming. Everyone seemed to be talking about their 401K plans and which mutual funds they were invested with, and how much money those funds were making. Peter Lynch and the Fidelity Magellan fund were the guys to beat. What made the mutual fund the favored investment vehicle for the masses was that they offered professional management, a diversified portfolio, and ease of use.
By the time the market peaked in early 2000 very few people could have anticipated what the next 10+ years had in store for us. Over the course of that decade investors watched their diversified buy-and-hold equity portfolio cut in half – not once but twice – by two gut wrenching market declines. In 2000 we investors harkened back to 1987 and kept waiting for the market to find a bottom and begin its rally higher. The bottom eventually came, but not until March 2003. We watched the carnage unfold even faster in 2008 and when we thought back it wasn’t to 1987, but to 1929 as politicians and the nation’s bankers brought the world to the brink of financial collapse.
I have thought back on that original advice. About the idea of “staying the course” of “buying and holding” and whether in today’s financial marketplace whether diversification is sufficient protection for the average retail investor…like me. After speaking with investors of different ages and from many walks of life the answer to that question is a resounding “no.”
The world’s markets are intertwined and correlated like never before. The idea that diversification on its own will insulate investments from financial loss over the long term was proven to be wholly inadequate over more than a decade of market sell-offs. Mutual funds have not delivered the kinds of returns needed by investors planning – now just hoping – to one day retire.
Seeing first hand the stress, the disappointment, and the shattered hopes of a great number of people who had trusted in the common investment mantras of “Buy-and-Hold,” “Diversify,” “Dollar Cost Average,” and “Re-balance,” it became important to me to really evaluate the traditional advice given to the retail investing public to understand where it came from, why it is given even today, and if there was any merit to such advice consider whether there were simple steps that might be implemented to give the retail investor a better chance of prospering.
The good news is that I have been able to answer all of these questions. To do so I have called upon my contacts within the financial industry from my years operating TheOptionClub.com trading community to gather the necessary information and insight. I have evaluated claims made by many of the investment advisory and educational services that promise more profitable ways of trading and investing. It has been an “eye opening” experience and one that I would like to share with you.
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Christopher Smith
TheOptionClub, LLC