Or, How We Discovered the Real Y2K

By Carol Clark

(ARA) - Was it really just a year ago that we were all running around trying to prevent computers from coming to a grinding halt on the first of January, and speculating about civil unrest and traffic jams around the globe?

Time flies, even if the ensuing year hasn't been much fun for investors. In hindsight, I'd say the real Year 2000 Bug was the gut-wrenching flu that struck the stock market, bringing a big dose of reality back into the picture.

For those of us who have participated in the investment arena for more than just the past couple of years, 2000 will likely go down as "not unprecedented and long overdue." For the investors who have come to the party more recently, it was a brutal, eye-opening, and sobering experience. Buying every dip didn't work. Dot-com IPOs didn't work. This year was truly a coming-of-age experience for millions of "adolescent" investors.

Those willing to stay the course benefited from a number of important lessons. In the style of that famous late-night talk-show host, here are the "Top 10 Things We Learned about Investing during the Year 2000."

Lesson Number 10: Yes, Virginia, There is a Wealth Effect.

I get frustrated when strategists point out that there's little correlation between what the stock market does and how optimistic consumers feel. Virtually everyone is involved in the market -- at least tangentially. And it's only natural to think twice about every purchase you make when the value of your investment portfolio is declining by double-digit amounts. Just ask the folks whose loans are tied to severely under-water stock options: Negative debt positions have a funny way of curbing spending.

Lesson Number 9: Rapidly Rising Markets Make Questionable Stocks Look Like Good Investments.

This is similar to the fact that floodwaters make a lot of things float that aren't actually boats. In a heady environment, the quest for the quick buck rapidly overtakes common sense, and companies with questionable business plans get funding (from venture capitalists) and attention (from analysts hoping for investment-banking business). Just because someone is willing to fund it or follow it doesn't make it a legitimate business plan or a viable long-term investment.

Lesson Number 8: Dot-Coms as an Asset Class Crashed; Dot-Coms as Businesses Didn't.

By some estimates, 95 percent of the pure Internet companies that went public in the past couple of years eventually will fail. Many already have done so -- with a lot less fanfare than when they were offered. Nonetheless, their very existence scared the daylights out of many "old-line" businesses, which quickly responded with their wherewithal, existing infrastructure, and newly energized management. These "new Old Economy" players are now wiser, stronger, and more nimble thanks to the brief threat from on-line competitors. I'm sure it's sweet justice for them to have the employees who jumped shop for greener pastures come running back -- even as the stocks of dot-com competitors fade faster than Fourth of July fireworks.

Lesson Number 7: Investing isn't for Wimps.

Gambling (read "day trading, IPO flipping, buying on hot tips, et cetera") is best done in casinos. Even though the economy, technology, and the world political scene all change, certain basic rules don't. To be a lasting entity, a company has to make a profit at some point. Another way to look at it is that in an economy growing at 3 percent or even 7 percent, most companies can't grow at 30 percent or more for an extended period of time. Investing requires thought, not hot tips. It requires thorough research, not direct-from-the-management PR.

Lesson Number 6: Leverage and Volatility are a lot More Fun on the Upside.

For five years prior to 2000, both the stock and bond markets basically went up, as the best of investment environments -- improving productivity, declining interest rates, stable political environment -- kept getting better. "Volatility" was great, because it really only went up. While a lot of folks suspected things were going too far in one direction, it was too exhilarating a ride to disembark. The flip side of volatility became painfully obvious as 2000 dragged on, however, and many high fliers plummeted from triple digits to double digits. . . and then on into single digits.

Lesson Number 5: "Asset Allocation" isn't such a Nasty Phrase After All.

Our reacquaintance with the dark side of volatility and leverage introduced many all-equity cowboys and cowgirls to the concept that owning a few bonds, some real estate, or (shock of all shocks) a higher cash position might not be such a bad idea after all. A little stability in one's portfolio might, in fact, allow a day or two of rest for the Tums bottle.

Lesson Number 4: Even if Your Statement Shows a Gain, the Money isn't Yours to Keep.

This was perhaps one of the toughest lessons to learn, as we all became mesmerized by our steadily rising brokerage account balances. Yet the reality of investing is that until you convert some of the asset to cash, the gain is not truly yours to keep. (And even the process of conversion means giving up some of your gain to the IRS and inflation.) The bottom line is that whether you convert assets or let them ride, the stock market doesn't "owe" you the 20 percent or 30 percent annual gains to which many of us became accustomed. The long-term average is still closer to 8 percent or 10 percent.

Lesson Number 3: Time and Rest are the Best Cures for the Flu.

As painful as it was, we hope last year will prove to have been a beneficial rest period in an overall upwardly biased market. It has been useful for wringing out some of the speculative excesses spawned by hedge funds, venture capitalists, day traders, newcomers, and leveraged participants. Last year forced all players to re-examine their strategies and focus on thorough analysis.

In the meantime, the economy has been healthy. Corporate America has become even stronger and more competitive. And valuations have retreated to more comfortable levels -- all of which leaves stocks well-positioned for the coming years.

Lesson Number 2: When the Going Gets Tough, the Tough Stay Put.

Despite the frustrating nature of 2000, it still wasn't worthwhile to jump in and out of the market. Many studies (and even more war stories from market vets) will attest to the fact that no one can successfully pick tops and bottoms. If you want to fully participate when the market starts to move, you have to be in place already. If your analysis has been patient and thorough, you will be positioned in the companies that are likely to lift off first.

Lesson Number 1: Fear and Greed Still Rule the Roost.

Since the earliest days of American trading under the old buttonwood tree, these two emotions have ruled investors' actions. That's true despite the attempts of business-school professors to prove that some scientific system guide investors' choices. It's been a long time since we've seen widespread fear, but it's somewhat reassuring to know that the more things change, the more the basics of investing stay the same.

Carol Clark is a principal with Lowry Hill, a comprehensive, private-wealth management firm with $6.9 billion in assets and offices in Minneapolis, Naples, Fla. and Scottsdale, Ariz. She can be reached at cclark@lowryhill.com.







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