Betting on the Market

Special Reports

How they should view it....And how they do view it By Ken Kurson

Ken Kurson is staff writer for Worth magazine and editor and founder of GREEN, a personal finance magazine for those made nauseous by the phrase "personal finance."

On October 19, 1987, the Dow Jones Industrial Average dropped a record 508 points. I was four days shy of my 19th birthday, smug and ignorant in the way all kids should be at that age. But even a dim-bulb punk like me understood that a 22.6 percent decline in the market was not simply the ups and downs my dad had told me to expect when I made my first bet on the stock market with my bar mitzvah money six years earlier.

I called my broker at Merrill Lynch for the first time in about three years. How bad was the damage? Let's put it this way--I'd beaten the Standard & Poor's 500, the benchmark by which stock performance is measured. Um, except for one thing. I'd beaten it in the wrong direction. During Fall 1987, the S & P 500 lost almost 30% of its value. But my little nest egg had tumbled from $5,000 to under $3,000--a catastrophic 40% swoon. Goodness gracious.

Faced with a near halving of my net worth, I took a look around, reread my treasured investment books and reabsorbed their maxims: "Invest for the long-term," "market dips are buying opportunities." I re-examined the venerable Ibbotson charts that hung on my wall like a stock-market centerfold, and saw anew that one simply couldn't argue with the history of stocks versus other investment classes. And then I made my decision.

I am a professional personal finance writer for a "real" magazine (Worth) and the founder and editor of a personal finance magazine aimed at young people. So it'd give me great pleasure to report that I calmly redialed my broker and ordered him to buy whatever he could, using whatever margin my lowly three grand could produce. That sort of steely countenance is legendary on Wall Street and fortunes are made by people who don't run at the first sign of trouble. But I wasn't on Wall Street. I was on Clark Street in Evanston, Illinois, and the prospect of losing everything was simply too daunting to behold. I redialed my broker, alright. Then I made him sell every stock I owned, and used the cash to buy a beat-up Nissan Stanza.

I'm not exaggerating when I say that I experience actual physical pain when I think about what those stocks would be worth today had I ridden the two bull markets that have occurred since November, 1987--a gain of 71.2% from 12/87 to May 1990 and a gain of 165% and counting from June 1990 to today. Nevertheless, I think I got a good deal from the debacle. In addition to putting over a hundred thousand miles on the Stanza, I learned a lesson with a force simply not available via the written or spoken word. No matter how many times I read that my maneuver was exactly wrong, I didn't really grasp its damning effects until I actually watched the market soar without my three grand in it.

Cut to late 1996.

The Dow is about to post its second year in a row of 25%+ gains and there hasn't been a significant slow spot, aka "correction," since October 1990. (For the purposes of this discussion, we'll succumb to the glib shorthand of the mainstream personal finance press, which decrees that a 10% dip is a "correction" while a 20% tumble is a "crash.") The market seems to break 1,000-point barriers quarterly while setting new highs monthly.

These dizzying heights are giving the experts vertigo. Particularly troubling to these gurus is the fact that many mutual fund investors, and even a lot of mutual fund managers, have never really weathered a crash, having come to the market after 1987. Morgan Stanley legendary smart guy Byron Wien points out in a front-page, above-the-fold story in the New York Times that he has doubts about the young investor's resolve. Wien fears that we'll turn tail at the first sign of trouble: "Since there are so many new investors in equity mutual funds, the real question mark is how they will behave when and if the market corrects," Wien wonders, continuing, "The answer, probably, is not well."

This pisses me off. Because it's patronizing. Because it's condescending. And because it's probably right.

Young people are coming to the market at an unprecedented rate. In 1996, 34 percent of households headed by someone under 35 had some sort of mutual fund. That's a nearly 25% increase over the rate of ownership just two years ago in 1994. And stock mutual funds represent the biggest chunk of young investor's money. With some economists convinced that the reason the markets have been doing so well of late is the sea change of investors flooding the market with mutual-fund dollars, it's no mystery some think that a sudden exodus to safer investments will roil the stock markets.

But will young people bolt at the first sign of trouble? What about historical data that have been hammered into our heads by mutual fund companies in slick 401(k) presentations assuring us that stocks are the place to be over the long-term? Will we abandon those ever-higher chart lines simply because a pothole's been hit? And are there enough Nissan Stanzas to go around?

The answers, I'm afraid, are difficult to predict. On the one hand, a much greater proportion of market inflows now arrives through automatic workplace contributions. This money is less susceptible to the whims of investors, simply because it's by definition long-term investment and because it requires effort (a phone call), while doing nothing keeps the money flowing. On the other hand, inflows into mutual funds did indeed slow last July when the small stocks and technology companies of the Nasdaq led that exchange through a temporary valley. But on the first hand, when Alan Greenspan's notorious "irrational exuberance" remarks kicked the Dow's butt to the tune of 169 points, mutual-fund investors largely yawned and continued to shove money toward Vanguard, Fidelity, Putnam and the rest.

So where does that leave today's young investor? Well, I hate to be a cheerleader for the stock market, especially when, as an investor, I agree with those who think that stocks are overvalued at the moment I write this. But when all is said and done, I firmly believe that the temporary gauges of "overvalued" and "poised for a correction" are meaningless when compared with the indisputable history of modern investing. Since 1925, a mixed basket of small and large company stocks would have returned better than 11 percent--enough to turn $1 invested on January 1, 1926 to about $2,000 today.

So, if my 18-year-old cousin, flush with graduation cash, had $5,000 she could afford to invest and asked me what I think she ought to do with it, I'd tell her to buy an index fund and a couple of stocks she believes are interesting enough to warrant a look in the paper every now and again. But I wouldn't be surprised, or even disappointed, if she didn't take my advice. After all, you can still get a hell of a used car for $5,000.

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