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Market Perspective
Learning From One's Mistakes
 by Ernie Ankrim, Ph.D.
Director, Portfolio Strategy
Russell Investment Group
August 7, 2002
If you asked a group of people the question "What makes a good investor?" some of them would probably answer that it's someone who rarely makes mistakes. Someone who knows where to invest, and when.
I would argue instead that a good investor is one who makes the effort to learn from his or her mistakes over time. Some investors can dodge them in the short-term but mistakes are inevitable in the long run of an unpredictable market. It's making that effort to learn from mistakes that is invaluable over the long run.
Nonetheless, we see evidence now that many investors are on the verge of making the same mistake they made just a few years ago.
Fool me Once, Shame on You ... Fool me Twice, Shame on Me
During the heydays of the late 1990s, a lot of folks abandoned their diversified portfolios to take a concentrated bet on US large caps and technology stocks. To them, the idea of investing in bonds, gold, real estate or international stocks was downright ridiculous when compared with plowing it all into US equities. Now, a refined investing landscape later, these same asset classes look attractive indeed relative to the US equity market.
With the S&P/TSX Composite Index having lost 15.4% over the past four months and the S&P 500 Index having lost one-third of its value over the past 18 months, we're now seeing panic on the part of some investors. Some are saying that they just can't take the risk anymore and want to get completely out of equities and entirely into cash. Others want to shift their money from stocks into the asset classes that have been performing well recently.
It may be true that cutting losses is the best course for investors who had been counting on their equity investments to pay for expenditures in the next year or so. Their predicament, however, underlines the importance of making sure that your asset allocation stays in line with your stage of the investment cycle. It's naive to believe that the inherently unpredictable stock market can provide a source of steady returns for needs and goals just a year or two away. That's a lesson that investors with longer time horizons should heed. If you won't need the money from your investments for another 10, 15 or more years, bailing out of the equity market now would be as effective as closing the barn door after all the horses have bolted. And you'll be left with a portfolio that's woefully out of step with your investment horizon.
It's Never a Bad Time to Be Diversified
Although it's boring to hear the same advice all the time - sort of like a parent telling you to eat your vegetables - our advice today is the same as it has always been: Diversify. Of course, you may wonder if it makes sense to diversify into asset classes like bonds and real estate just when they have been performing so well recently. The answer, in our opinion, is yes, in moderation. Was there a better time to be diversified? Yes, a year or so ago. Despite that fact, it makes supreme long-term sense to diversify your portfolio (if it isn't already) precisely to avoid the type of painful losses in the future that many investors are experiencing now. It's a trade-off, but ultimately likely to be a worthwhile one. Diversification will probably prevent you from achieving the highest returns the market can offer, but it may also keep you from hitting the depths many investors are experiencing right now.
Investor, Know Thyself
The other important lesson an investor can glean from the current market environment is the importance of knowing one's own risk tolerance. For the many investors who entered the market in the mid-'90s or later, this exercise was largely theoretical. Until recently, most investors simply never had had the experience of a true-blue bear market and therefore couldn't adequately judge their own risk tolerance. Now, it's a different story. Having experienced severe losses, many more investors will be able to construct a portfolio that accurately reflects how willing they are to take on the risks associated with equity investing. And that's the most important lesson of all.
Date of first use: August 8, 2002
This is a publication of Russell Investments Canada Limited. It should not be construed as investment, legal, or tax advice. The contents are intended for general information purposes only, and you are urged to consult your own investment, legal, or tax advisor concerning your own situation and any specific investment questions you may have.
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