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Market Perspective
Resisting Temptation
 by Ernie Ankrim, Ph.D.
Chief Investment Strategist
Frank Russell Company
November 7, 2002
This article has been provided by our parent company, and primarily deals with the US market.
In this confusing market, many investors are making mistakes that are moving them farther and farther from attaining their long-term goals. Here, we explore one of the most dangerous pitfalls: abandoning a balanced approach to chase past performance. In Part II, we'll take a closer look at another crucial mistake investors make and consider sound ways to resist temptation and stay on track to long-term goals.
MISTAKE #1: Chasing Past Performance — This Time It's Bonds
For most investors, the arguments against chasing past performance are familiar territory. Yet we continue to see investors make this mistake again and again. A few years ago, many investors loaded up on stocks, especially large-cap growth equities, just as the asset class reached a peak. In January 2000, investors' net flows into equity mutual funds exceeded their flows into bond funds by $57 billion. And it was, of course, almost exactly the worst time to buy stocks.
When the tide turned abruptly, many of these same investors sold out of equities and retreated into cash.
More recently, we've seen a similar shift into bond funds, especially Treasury vehicles. During July 2002, flows into bond funds exceeded stock net flows by almost US$80 billion.
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| At Russell, we believe that balance is the key to long-term investment success. Through diversification across markets, asset classes, and investment styles, Russell's multi-manager portfolios provide investors with a balanced approach to the markets and a framework that can enable them to resist the temptation to chase performance or time the market. |
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Are these individual investors buying at the top of the bond market and selling at the bottom of the equity markets? Since no one knows if the stock market has hit rock-bottom yet, it may not be the absolute "best" time to buy stocks. But it is almost definitely a very bad time to sell.
Why It Happens
In investing, as in other areas of life, people naturally gravitate toward what's given them comfort and security and away from what's exposed them to risk and pain. That inclination can lead investors to doubt the value of holding bonds when the stock market is going gangbusters or abandon stocks when the going gets rough. Given that the past three years have been the worst stretch for equities in the past 40 years, it's not surprising that many investors have been losing faith in stocks and seeking a haven in bonds and cash. In fact, many investors — and even some experts — have gone so far as to question the very value of stocks as a long-term investment.
Why It's a Mistake
No one knows, of course, when the tide will turn in the market. There is anecdotal evidence, however, suggesting that individual investors who have been retreating from equities and flocking to bonds may be making yet another timing mistake.
Unfortunately, individual investors who are abandoning a balanced portfolio for Treasuries or even cash may be jeopardizing their future financial security. The fact is, Treasuries and short-term cash offer modest real long-term returns. At current interest rates, short-term bonds and cash merely enable you to stay one very small step ahead of inflation — even as your most important goals, like a comfortable and secure retirement, recede more and more into the distance.
There is also a common assumption that fixed income investments, regardless of duration, are close to riskless. In fact, while coupon payments remain consistent, interest-rate increases (and the resulting decline in the market prices of bonds) can create a significant drag on a bonds' total return.
Of course, bonds do have a necessary place in a diverse, risk-aware portfolio — and laddering their maturities can smooth their volatility — but moving to them out of fear of equities or desire for stability may keep your portfolio from reaching its goals.
Part II: For investors, living in the future can be just as damaging as living in the past. But there are some simple ways to help resist the temptation to do either.
Date of first use: November 13, 2002
The information, including any opinion, is based on various sources we believe reliable, but its accuracy cannot be guaranteed.
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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