Then there’s you. You responsibly followed the rules. You sought value. You bought and held. And you diversified your holdings. The result? Your dot.comless portfolio stinks. The manifest rewards of irresponsible investing suggest that it’s time to toss out boring old concepts like diversification and long-term investing. But is that really true? Let’s take a closer look at the tenets of this new-era market.
Don’t diversify: Anyone who’s spread his money among an array of investment categories looks like a fool right now. Emerging markets? They cratered through most of 1997 and 1998. Real-estate investment trusts? Their returns clocked in 44 percentage points below the Standard & Poor’s 500 last year. Japanese and small-company stocks? An entire generation has completed grade school since they last produced decent returns. Knowing that a simple-minded strategy–buying the S&P index or Microsoft in 1995 and falling asleep–proved unbeatable has only intensified diversifiers’ misery. “If a financial planner says he hasn’t heard from his clients about sub-index performance, he’s lying,” says Harold Evensky, a planner in Coral Gables, Fla. “It’s all anyone is talking about.”
So why not dump diversification? It’s hard to remember, but every market has its corners of outrageous fortune. Sectors start outperforming for solid financial reasons. But if the outsize gains go on long enough, those reasons turn into investment laws. By 1988 we all thought Japanese companies would dominate the world forever. By 1993 everyone knew that emerging economies were unstoppable. Should you have piled all your dough into one of those sectors? Of course not. “People forget that the point of diversification is not to enhance returns, it’s to reduce risk,” says Richard Bernstein at Merrill Lynch.
Ignore facts: Here’s the really fun part about today’s market–it’s like, you know, so easy. There’s no need to know how much a stock is really worth, what a company actually does or whether it’s profitable. Making money in the market is really just a matter of hopping on the train–or having the courage to be rich, according to the financial advice of a best-selling author.
What’s wrong with this investing-for-dummies approach? It makes you a follower, apt to be neck deep in hot stocks when the glacier looms up. It also leads to mistakes. Look at Perot Systems, a company started by Ross Perot that went public amid a stream of dot.com darlings. Priced at $16 per share on the evening of Feb. 1, Perot Systems opened at $33 at mid-morning the next day. Within a few days it hit $85. This would be just another story of a sizzling Internet IPO except for one thing: Perot isn’t an Internet company. Individual investors thought it was because of a mistaken news report, despite a prospectus that made Perot’s business–integrating corporate computer systems–amply clear. But who reads the prospectus? Mistaken identity drove Perot’s stock price to 160 times earnings, four to five times as high as competitors’. More than a few train-hoppers got hurt. Perot closed at $29 last week.
The sad thing is that they can. What’s wrong with that? Short-term trading is fanning a self-fulfilling, speculative frenzy that won’t end with everybody getting rich. It works like this. Many online traders prefer small-company stocks because they think they know more than the pros about such small fry. Internet IPOs are especially appealing. But because information is scarce, rumors run rampant. And because small stocks are thinly traded, meaning that relatively small purchases can produce large price movements, prices career wildly on news that may or may not be authentic. That volatility, of course, is what allows traders to turn a 14 percent profit–or more–in a day. The allure of fast, easy profits is pulling more and more ordinary folks into full-time trading.
Those ordinary folks could be in for some extraordinary losses, says Kathleen Smith, a portfolio manager at Renaissance Capital’s IPO fund: “When there is a bubble, which is certainly the case here, stock prices and values become disconnected.” The IPO market has never seen anything like the current rocket-ship launches of Internet stocks. But it has seen other bubbles. Biotech stocks went on a tear from 1989 to 1991. Gambling stocks were the rage in the early ’90s. Y2K stocks roared up 122 percent in 1996. Where are they now? Some are still around. Others are out of business. But few trade anywhere near their peak. What? You steered clear? Guess you’re not such a chump after all.
