What Not to Buy in a Bear Market

What Not to Buy in a Bear Market

These days, advisers are eagerly hawking what worked the last time
stocks tanked. Hold on to your wallet.

"Look at how well these investments performed during the 2000-02 bear
market!" This is the line I've been hearing from mutual fund companies
and other investment providers trying to sell me on the superiority of
their products (and get me to put clients into them).

That means I'm being pitched the standouts of the past bear market,
including small-cap and value funds, real estate and metals and
mining.

From the beginning of 2000 to the end of 2002 - when U.S. stock funds
lost 12% a year on average - small-cap funds dropped by 6.5% a year,
and value funds fell by just 2% a year, according to Morningstar. Real
estate and precious-metals funds - two groups that often do well when
the stock market slumps - delivered double-digit annual gains.

Many financial planners I've talked to are buying this pitch hook,
line and sinker and are investing clients in these funds. It's why
your adviser may be showing you pretty graphs nowadays that illustrate
how well his current recommendation stood up to the bear last time.

Weak Theory: This seems like a logical approach, until you realize
that it is based solely on one bear market. It's possible that what
happened once could happen again - but it's far from probable. In
fact, over the past year, while U.S. stock funds are down nearly 13%,
small-cap stock funds are down 14%, value funds 19%. So far, the logic
is failing miserably.

If your adviser is moving you into anything that did well during the
past bear market, not only is she engaging in straw-grasping but she
also doesn't understand the market. By hoping that what did well last
time will do well again, she's engaging in a form of performance-
chasing.

Long View: A much better strategy is to build a portfolio that holds
many different asset classes and stick with it. Once you have a proper
asset allocation, all that's needed is simple rebalancing. This is the
opposite of performance-chasing, since it means that today you
probably have to sell some of your safe bonds to buy risky stocks.

Let me clue you in to something: We advisers have no idea whether the
bear market is nearing the end or still has a long way to go. So don't
let any adviser shift you away from a long-term strategy under the
guise that he knows what's going to do well next year. A quote I often
use by Warren Buffett, "Be fearful when others are greedy and greedy
when others are fearful," particularly resonates now.

The Mole is a certified financial planner and certified public
accountant who - in the interest of fairness - thinks you should know
what goes on behind the scenes in financial planning.