Chet Currier—Old Habits Could Die Hard for Investors in Stock Funds

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The new generation of investors in stock mutual funds doesn’t discourage easily.

If any doubts linger about that oft-demonstrated trait, they should be dispelled by the latest reports on flows of money into and out of the $7 trillion-plus fund industry.

In a down year for stocks, investors have nevertheless plowed record amounts of money into growth stock funds, the very sector that has suffered the most damage from the serial sell-offs that have hit the market in 2000.

Over the first nine months of the year, according to the Boston consulting firm Financial Research Corp., investors bought $155.4 billion more of domestic stock funds than they cashed in. That’s 39 percent more than in the same stretch of 1999.

On a net basis, funds specializing in U.S. stocks got every penny of the money that went into all types of long-term funds sold in this country. The other species, bond and international and global stock funds, mostly sat and watched.

It takes a party-pooper to criticize investors for buying into a weak market. They are only following the sensible advice they’ve heard from the experts to stay with their long-term investment plans and to take advantage of cheap prices. How else can you hope to stay on track for goals like a prosperous old age?

But I am going to carp here. Even though they are doing the right thing, it may not be for the best of reasons. Before their optimism is validated, it could be subjected to a lot more pressure than they’re accustomed to.

The stock market has trained us all over the last 20 years to expect quick and generous rewards for buying the dips.

After 1981, when the Standard & Poor’s 500 Index fell 10 percent, it rebounded 15 percent in 1982. A 1.4 percent rise in ’84 led into a 26 percent jump in 1985. After 1987’s 2 percent gain, ’88 was up 12 percent and ’89 added 27 percent more. Buyers during the 6.6 percent drop in 1990 were rewarded with a 26 percent gain in ’91. A 1.5 percent loss in ’94 was followed by a 34 percent upsurge in ’95, and three more bang-up years after that.

That brings us to 2000, which has produced a 2.9 percent loss in the S & P; 500 through the end of October. If experience is any guide, 2001 ought to be terrific. Trouble is, experience isn’t always a reliable guide in the markets.

“I think this decline is different from the others,” says Peter L. Bernstein, an economic consultant who has written authoritative books on risk, gold and other investment subjects. “The days of wonder, if they’re not over, may at least be changing.”

Or listen to Bill Gross, who manages the biggest of all bond funds at Pacific Investment Management Co.: “What we may experience is the first cyclical downdraft of our New Age economy. I believe we should stand by and be on the alert for the winter winds of economic and investment change.”

My point in citing these voices of caution is not to predict some impending calamity. As Bernstein says, “I don’t trust anybody’s market forecast, including my own.”

The last thing I’d want is to scare anybody out of his or her long-term investment plan. What also strikes me, though, is that a good plan for the next several years ought to take into account the possibility that stocks might stop repeating the fast-rebound pattern of the past two decades.

That mandates staying diversified, both by owning different types of stock funds and by keeping some of your money out of stocks altogether in, say, Treasury bills or money-market funds. It argues for visualizing the future using conservative assumptions, restrained expectations.

This is not just theory: Stocks have a history of abusing their best students. For 15 years from the late 1960s through the early 1980s, the Dow Jones Industrial Average established what looked like a trading range for all seasons. Whenever the average hit 1,000 in 1968, in 1973, in 1976 and again in 1981 it was time to sell. You could buy back in again below 800, as happened in 1970, ’74, ’77, ’80 and ’82.

So in the second half of ’82, when the Dow hit 1,000 again, the “smart money” sold once more, just as one of the biggest market advances of all time was leaving the launch pad.

You couldn’t blame people for selling; they were just doing what the market had taught them to do. Only later did it become apparent that stocks had embarked, with no warning, on a different course.

Chet Currier is a columnist for Bloomberg News.

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