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Rational Investing

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by Clark Davis

Are you puzzled by the performance of your investment portfolio for last year when you compare it to the Dow Jones Industrial Average or the S&P 500? Guess what? You have a lot of company.

Before going any further, ask yourself the question, "Is my benchmark for performance an average or index, or is it a targeted rate of return based on my risk tolerance relative to historic rates of return and considering any fixed income investments in my portfolio?"

For most serious investors the averages hold only limited relevance. What is most important is whether you are on track to reach your specific goals. To that end, it is worth listening to the advice of Peter Lynch when he talks about longer-term perspectives in those ubiquitous Fidelity commercials on television.

Having said that, let's look at why most investors did not do as well as "the market" in 1998.

Here's what one of my favorite equity strategists, John Manley, of Salomon Smith Barney, wrote about the strange market of '98:

"Our work indicates that 10 stocks were responsible for almost half of the S&P 500's rise. For all its oddities, 1998 will go down in history as the year in which 10 percent of the stocks and 2 percent of the days provided almost all of the gain (in the S&P 500).

"As of Dec. 18, more than 70 percent of stocks (358 names) in the S&P had lagged the index in the year. The median gain for an S&P constituent was a scant 2 percent. Thus, while 1998 may be remembered as a great year for equities and equity investors, in truth there was very little easy money to be made."

The year was especially frustrating to a lot of investors who owned issues that remained undervalued by historic measures, while some of the overvalued larger companies grew more overvalued and Internet issues with piles of debt and mounting losses exploded to the upside.

If, for example, you owned well-run, financially sound smaller capitalization companies, you may have observed the market overlook, or even show disdain for, your stocks. Such a valuation dichotomy was reflected in the performance of the Russell 2000, which ended the year with a 3.5 percent loss.

If you are one of those investors, stay your course. Don't let disappointment, frustration or greed cause you to abandon a sound approach in hopes of being able to get on the runaway train of speculating.

Getting on the speculation train is one thing, but how will you know when to get off before it crashes? And crash it will. Bubbles burst from the tulip mania of 1635 (see my column of May 25, 1998) to the computer leasing companies to the biotechs. And there will be a shakeout of the Internet companies. The fact that there is a .com at the end of a company's name does not guarantee success.

Competition and the need to be profitable have always separated the wheat from the chaff. At the turn of the century, there were more than 500 automobile manufacturing companies. And now? Food for thought.

If your investment discipline or that of your mutual fund(s) has served you well for the past five to seven years, but did not provide the return that you expected this past year, don't rush to change. No discipline or style works equally well in all markets.

One of the mistakes inexperienced investors often make is to sell a mutual fund that has under-performed over a short period of time in order to acquire a fund that just turned in a sizzling rate of return. If the under-performance was simply a matter of the style being out of favor and the management and discipline remain the same, be patient.

Of greater concern would be a change of style, a problem we have seen increasingly as many money managers in search of short-term performance have abandoned their discipline in an attempt to enhance performance by chasing what's "hot."

For example, if your mutual fund espouses a value philosophy and you find a significant number of high p/e issues in the portfolio, ask your investment professional to evaluate your funds. If you and he determine the managers are playing the hot performance game rather than adhering to the discipline for which you acquired the fund, get out.

(Clark Davis is a 30-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money management company. Questions or comments can be directed to him by mail via The Springfield Business Journal, 313 Park Central West, 65806 or by e-mail at clark@slia.com.)

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