Join the Party Before It's Already Over

Sometimes being late can be a goodthing. For example, showing up laterthan everyone else at a party gives guestsa chance to notice your arrival. And everyoneenjoys making an entrance every nowand then. But when it comes to the stockmarket, late arrivals usually don't getnoticed. By the time latecomers show up,the party is usually over.

EVERY MINUTE COUNTS

Chasing performance (ie, putting thebulk of one's investment funds intotoday's hottest single asset category, sector,or security) is like arriving at a partywhen it's half over. The chips and dips maystill be around, but all the big shrimp havebeen eaten by the earlier arrivals. Manyinvestors were late to the stock party backin the 1990s, missing the big years 1995 to1997, when large cap stocks returned37.5%, 23%, and 33.3%, respectively. Returnswere still excellent in 1998 and 1999,but the party was over by 2000.

Nowadays, bonds and real estate mayrepresent 2 new parties that manyinvestors are arriving at too late. Forexample, investors have been fleeingstocks and going into bonds in a kind ofmass migration, last seen in the late 1990s,when investors piled into stocks. Duringthe first 9 months of 2002, according tothe Investment Company Institute, a netincrease of $120 billion was invested inbond funds, eclipsing the full-year recordof $103 billion set in 1986.

But the past 2 times investors rushedinto bonds (ie, 1993 and 1998), bondssuffered weak returns the followingyear. The potential problem for investorsbinging on bonds now is thatinterest rates are at record lows. Thereason bond and bond fund returnshave been so good since 1999 is thatinterest rates have plunged dramatically.Bond prices move in the oppositedirection of interest rates. Since ratescan't get much lower, the bond expertsworry that once the economy improves,and inflation rises, interest rates will riseand bond prices/returns will fall.

Real estate may be at a similar point.For example, after 2 poor years in 1998and 1999, real estate investment trusts(REITs), which invest in everything fromshopping malls to mortgages, returned26% in 2000 and 15.5% in 2001. Wheninvestors finally realized how well REITswere performing, they began pouringmoney in REITs—just in time to see REITreturns slip to slightly over 4% during thefirst 3 quarters of 2002. Investment prosreportedly are already moving out of realestate and back into battered stocks.

TIME IS MONEY

Evidence suggests that during a marketrecovery, the best of the returns tend tooccur early. That is certainly the case withstocks, according to a study by SEIInvestments, which has examined 12 bearmarkets since World War II. SEI found thatinvestors who either stayed in the marketthrough its bottom, or were fortunate toenter at the bottom, saw the S&P 500 gainan average of 32.5% (minus dividends)their first year. Investors who missed onlythe first week of the recovery saw gainsthat first year slide to 24.3%. Those whowaited 3 months before joining the partygained only 14.8%.

Of course, there is no way to predictexactly when the bottom will occur orwhat sector will become the next hotone. In addition, it's not correct to assumethat you shouldn't be investednow in real estate or bonds. That's whyfinancial planners counsel investors notto forsake one asset class in favor ofanother one. Instead, they advise investorsto diversify among asset classes.Studies show that a good mix of assetcategories usually provides superior andmore stable long-term returns than tryingto time the market by heavily overweightingin a single category.

This column is produced by the Financial

Planning Association (www.fpanet.org), the

membership organization for the financial

planning community.