Don't Follow the Herd
Edition: June 2002 - Vol 10 Number 06
Author: Richard Yercheck
There's a theory on Wall Street that goes something like this: If you follow the crowd and purchase the hot investment of the day, chances are you'll be scooping up shares when most others are getting ready to sell. This theory, known as ''following the herd,'' can have you buying at the wrong timeand not buying when you should.
Investors often jump into an investment at the wrong time because they are worried about what others are doing instead of focusing on good old-fashioned fundamentals, such as the company's earning potential or its management.
History has continually shown us that when individuals make investments without a prudent basis for doing so, they often wind up losing money that can take many years to recover. We saw this in the mid-1980s when investors drove up the price of California real estate to dramatically high levelsonly to see the market collapse.
History has also shown that when individuals avoid investments because the popular thinking is to steer clear of them, opportunities are often overlooked. We saw it in early 1982, when interest rates were high and companies had a difficult time impressing analysts with their earning potential. That period proved to be the early stage of a bull market that lasted more than five years.
On October 19, 1987, the Dow Jones industrial average fell 508 points in one trading session, as investors scurried for the sidelines in what was the single worst trading day since October 1929. However, that day proved to be a tremendous buying opportunity. Since then, stocks, as measured by the broad market averages, have quadrupled in value.
More recently, at the end of 1994, a year in which stock and bond markets both struggled because of higher interest rates, the common thinking was that 1995 would be a bad year for the financial markets. If you took that advice, you would have missed out on one of the stock market's best years in this half century.
Eventually, the stock market is going to experience a period of lower prices. While market downturns can cause some investors to shift a greater percentage of their assets to money-market funds when times get tough, time and again this strategy has proven to be a mistake.
Keep in mind that the stock market has experienced nearly twice as many bullish periods as bearish periods over time. And while past performance is no guarantee of future investment results, the stock market has bounced back from every major market downturn to date.
When times get tough for stocks, maintain your confidence in their long-term growth potential by employing these simple strategies:
Reduce your cost by averaging down. If one of your stocks declines in value, consider buying more shares. You will reduce your overall cost basis.
Stay diversified. Keep your assets spread among investments likely to perform differently under the same market conditions. Profits from appreciated investments will help offset losses from any losing investments.
Stay focused on your long-term goals. Don't try to avoid the downturn by jumping out of the market. No one can accurately predict when it will rebound. Remembering why you invested in the first place will keep you calm during times of market uncertainty.
ABOUT THE AUTHOR:
Richard Yercheck is a Financial Consultant with IJL Wachovia in Charlotte NC. For more information, please call Richard at 800-929-0724. IJL Wachovia is a division of Wachovia Securities, Inc., Member NYSE and SIPC and a separate non-bank affiliate of Wachovia Corporation. © 2001 Wachovia Corporation.