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March, 2001


The 1990s stock prices bubble, which caused many to think, yet again, that it was "different this time," so that traditional measures of value no longer mattered, has been burst. Since its record high, well over 5000, on 3/10/00, the NASDAQ has now fallen over 62%, as of 3/16/01, to 1891. Millions who followed a momentum approach to speculating in the equities markets, sometimes even using a lot of margin debt to assist their purchase of the recently high-flying securities, have lost a great deal of money. This past week saw over a trillion dollars in losses, in this country alone, based on the reduced market value of stock shares. I personally know folks who've lost 50% or more since 3/00.

Some point out, however, that, by those previously spurned measures of value, such as price to book, to earnings, to net cash flow, or to dividends, with relative freedom from debt, both the Standard and Poor's 500 Index of large company stocks (with a price to earnings ratio of roughly 25) and the NASDAQ (with a P/E of roughly 150) are still overpriced (compared, for instance, with an historical average P/E of about 15).

Should a nervous investor sell all his or her equities and put the proceeds under a mattress? Probably not. But, unless already well allocated, it may be worthwhile to assure either that your long-term assets are well diversified or that you know enough about evaluating and selecting securities that you have already chosen for your portfolio ones that represent good value for the prices you paid.

In his investment classic, The Intelligent Investor, Benjamin Graham, the father of value investing, differentiated between two types of investor: the active and the passive. The active investor has gone to the trouble to learn how to discern the few companies whose shares are available at truly bargain prices, as opposed to the many who may deserve their currently low level in the market or which have been priced way beyond true value. Such an investor can carefully build his/her own portfolio with such low price to value nuggets, each having a margin of safety. On the other hand, the passive investor does not have the time, temperament, or talent to find and collect such gems and should be content with a somewhat lower level of return on investments kept in a very well diversified portfolio, with the assets held either suggested or managed by someone else, preferably someone who is competent as an active investor. Most of us, fortunately or not, would probably fit more in the passive category.

For these, to avoid the significant hazards of either selling out of too much worry, when the markets have just dropped, or buying out of too much greed, when they have just risen to irrational levels, he recommends fixed allocations of asset classes, to be maintained preferably in good times, bad times, and everything in between.

A typically recommended diversification for an investor with average risk tolerance and ability to hold onto assets for the long-term is as follows: 10% in interest paying stable reserves of one type or another; 30% in bond assets; and 60% in a portfolio (or mutual fund[s]) of stocks.

Had an investor begun with $100,000 with that allocation, in appropriate Vanguard mutual fund holdings, on 1/1/91, protected from taxes in the interim by a retirement account, and with dividends, interest, and capital gains reinvested, here is how things would have come out by 12/31/00, exactly ten years later: $377,052.

Initial Value
Final Value
Vanguard Prime Money Market FundVMMXX$10,000$16,320
Vanguard Total Bond Market IndexVBMFX$30,000$63,578
Vanguard 500 Index Fund Investment TrustVFINX$60,000$297,154

This year, through 3/16/01, if our hypothetical investor had reallocated the assets to restore the 10/30/60 percent respective allocations effective at the end of 12/31/00, he/she would have lost not the 12.65% the S. & P. 500 Index Trust was down so far, but just 6.329%, overall. The investor's total portfolio would still be worth $353,188, a gain of $253,188, or better than two and a half times the original amount.

Meanwhile too, despite the ups and downs of the markets over that ten year, 2½ month period, most investors with this kind of portfolio diversification could have remained relaxed about their holdings. Sure, it would not have been as exciting as speculating on the latest dot-com initial public offering; but it would let you sleep at night while your assets slowly and surely accumulate.

The first decade of the new millennium is unlikely to be as rewarding for even conservative investors as the last one was. But I contend the way to deal with that is not greater speculation, but a renewed commitment to a careful allocation of your investment resources. If one gets to feeling frustrated with less than stellar returns, there is another option inherent in Benjamin Graham's wisdom. Put your energies into becoming an expert at valuing securities. Then you can gradually move out of the plebian world of the passive investor and take active control of acquiring wealth for yourself, but with your motto: "safety first."


Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

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