The nature of the investment business is to look forward. We always seem to be asking, “What will the market do this year? Where are stocks headed?”
But you can learn a lot about the futility of such questions by looking back.
Check out the prognostications for 2001. “The U.S. economy isn't headed into recession, and the technology sector is far from dead, say our market gurus,” read the February 2001 issue of a popular financial monthly. Those gurus, by the way, were identified as “leading Wall Street investment experts.”
Of course, we now know the recession began a month later and the tech sector did not experience a rebirth.
And that was just one example of failed forecasts. Last year, for the second year running, almost every strategist on Wall Street got it wrong, according to a January report in The Wall Street Journal. Their projections for the S&P 500 ranged from 1,225 to 1,715 — all above the close of 1,158.31.
And let's not forget those books that were all the rage before the bull market ended — “Dow 36,000,” “Dow 40,000” and “Dow 100,000: Fact or Fiction.” Fiction, apparently. It would be interesting to know how book sales are faring now.
No One's Perfect
I'm not reciting these erroneous projections to knock forecasters. Most forecasters admit they must be prepared to miss the mark fairly often. Hey, sometimes they get it right. And I'm certainly not saying I could have done any better.
My point is that predicting stock market movements is tough at the best of times. No one knows precisely what the future will bring — in stocks, in politics and in life. Russell continuously monitors the performance of thousands of money managers — and we haven't found one yet who can accurately forecast future events on any sort of consistent basis.
So, how do you construct “future-protected” portfolios for your clients?
The solution is — dare I say it? — predictable. Diversify, diversify, diversify, says my colleague, Ernie Ankrim, Russell's director of portfolio strategy. Not exactly sexy advice, but important nonetheless.
First, he advises, diversify your clients' portfolios across investment types and economic sectors, so they will be positioned to do reasonably well regardless of market trends. “Diversification does not only mean that investors should have holdings in bonds as well as stocks — although it means that, too,” Ankrim says.
Stock holdings should include domestic and international investments. They should be in value as well as growth stocks; large-cap, mid-cap and small-cap stocks, and in a variety of sectors and industries. Bond investments also should be spread across short-term, long-term, government and corporate bonds, among others. Mutual funds, of course, represent one way to do that.
Also, adds Ankrim, “You might want to consider real estate as an added diversification.”
The best way to achieve such broad diversification is through mutual funds and appropriately diversified separate accounts, which reduce clients' exposure to possibly volatile individual stocks. Ideally, those mutual funds and separate accounts should have a variety of managers who bring different investing styles to the table.
Second, rebalance your clients' portfolios when necessary to ensure that you retain the mix with which you began, Ankrim suggests. By rebalancing, you ensure that your clients do not have too much of their portfolios in one asset class. They also will sell stocks — or bonds or anything else — when they have grown in value and then invest in other assets that are lower in value. Remember the concept, buy low, sell high?
Having “future protected” their portfolios with your help, your clients can listen to all the forecasters they like, even consult astrologers about the future. Your job is to stop them from acting on what they hear. Outlining what happened to last year's forecasts might be the best way to convince them.
Greg Stark is director of U.S. individual investor services, Russell Investment Group.