Five Lessons From the Nasdaq Bubble

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Five Lessons From the Nasdaq Bubble

Gregg Greenberg
Five Lessons From the Nasdaq Bubble
By Gregg Greenberg
TheStreet.com Staff Reporter
3/10/2005 6:59 AM EST
URL: http://www.thestreet.com/funds/gregggreenberg/10212371.html

Most of us would probably sooner forget the popping of the tech bubble.

Nevertheless, Thursday brings the five-year anniversary of the all-time peak in the Nasdaq Composite. Back on March 10, 2000, the index hit 5048, as hefty gains in highflying favorites like eBay (EBAY:Nasdaq) and Rambus (RMBS:Nasdaq) overcame setbacks in hard-chargers Amazon (AMZN:Nasdaq) and Yahoo! (YHOO:Nasdaq) .

Since then, of course, the tech market has suffered through a wrenching correction. And even now, with the Nasdaq having almost doubled off its fall 2002 low, the index remains 60% below its 2000 high.

[TheStreet.com also asked Greg Luttrell, manager of the TIAA-CREF Growth Equity fund, to look back at the bubble and how far we've come since the top of 2000.]

So regardless of whether there's any minibubble forming in the market now, it's worth taking a quick refresher course on how you can avoid the massive losses that countless investors got socked with the last time around.

1. Don't Forget to Rebalance

Rick Bloom, financial adviser with Michigan-based Bloom Asset Management, says one of the biggest mistakes people made during the boom was not rebalancing the assets in their portfolio on a yearly basis.

"The Nasdaq was so good in 1999 that by the end of the year, people's portfolios were grotesquely overweight with technology stocks," says Bloom. "And instead of pruning their positions, they just let it ride."

Bloom partly attributes investors' unwillingness to pay taxes on their gains as a reason why they allowed tech stocks to overrun their portfolios like weeds in a garden.

"The goal is never to lower your taxes but to put money in your pocket," says Bloom.

2. What Goes Up...

The dot-com bust wasn't Bert Whitehead's first encounter with a financial bubble, and the 50-year industry veteran expects it won't be his last.

Whitehead, the president of Michigan-based Cambridge Connection, a fee-only financial planning firm, remembers the public going similarly overboard in the 1950s with uranium stocks, in the '60s with plastics, in the '70s with gold and in the '80s with real estate. His conclusion: "No matter what it is, the hot sector of the decade will inevitably spin, crash and burn because there is too much money thrown at it."

Despite history being against him, Whitehead hopes the memory of the last bubble lingers long enough to enable at least some investors to "steer clear when they see a stock mania approaching."

3. Sell Your Losers

Gary Mandell, financial adviser with the Chicago-based Mandell Group, asks, "How many times does your broker call you with a sell recommendation as opposed to a buy?"

The answer for most investors is hardly ever and, as Mandell points out, it was even less so during the Internet boom, when stockbrokers would encourage their clients to ride their losers down, while finding additional new stocks to buy.

"Psychologically, it's tougher to sell your losers because it's an admission of a mistake," says Mandell. "And stockbrokers and individual investors were loath to admit their mistakes until it was too late."

Don Sowa, a financial adviser with Rhode Island-based Sowa Financial Group, offers a good solution to prevent investors from repeating this particular mistake: "Don't forget about stop losses." A stop loss is an order placed with a broker to sell a security when it reaches a certain price.

"You have to have a mechanism in place to protect you from yourself," says Sowa.

4. Walk On By

Tim Medley, financial adviser with Mississippi-based Medley & Brown, offers a bit of common sense that was often forgotten during the go-go years: If you know a stock is ridiculously overpriced, don't buy it!

"If you wanted to buy a local tire or grocery business, then you would look at their financials and come up with a valuation," says Medley. "If it's reasonable or undervalued, then you buy it, if not, then you just walk on by."

Medley says that with all the online financial tools available for investors, there is no excuse for not knowing if a stock is trading at an unsustainable price-to-earnings multiple, for starters.

"You need to put the time into researching the stocks you buy," Medley says. "It's not as easy as listening to your neighbor for the latest great stock tip."

5. Don't Forget to Diversify

"Trying to get people to diversify back then was like pulling teeth," says Deborah Voso, financial adviser with Maryland-based Voso Associates. "I remember making a presentation to five AOL executives at the time who were loaded with AOL stock and I was pleading with them to diversify into bonds."

So what happened?

"Only one of them did. And he's loved me ever since," says Voso, adding that she has found it less necessary to "pull teeth" to get her clients to diversify since the bubble's collapse.

Rule No. 5: Diversify to Control Risk
By James J. Cramer
RealMoney.com Columnist
3/11/2005 8:26 AM EST
URL: http://www.thestreet.com/funds/smarter_up/10212620.html

If you control the downside, the upside will take care of itself. I have always believed that to be the case. But controlling the downside means managing the risk.

The biggest risk out there is sector risk. I don't care how great a tech stock was in 2000 -- even eBay (EBAY:Nasdaq) and Yahoo! (YHOO:Nasdaq) -- if you had all your eggs in that sector, you got scrambled. Same with pharma in the last three years. Or oil in 1982, when I broke into the business.

What can keep you from getting nailed by sector risk, which is about 50% of the entire risk of owning a stock?

Diversification.

It's the only investment concept that truly works for everyone. If you can mix up enough different sectors in your portfolio, you can't be hit by one of the myriad perfect storms that come our way far more often than you would think.

Why aren't more people diversified? Many amateurs don't know the stocks they buy. They end up with stocks that are frighteningly similar. When I started playing "Am I Diversified" on my radio show in 2001, I was blown away by how few people knew just how undiversified they really were.

I still field quite a few calls from people who genuinely think that owning Sun Microsystems (SUNW:Nasdaq) , EMC (EMC:NYSE) and Microsoft (MSFT:Nasdaq) is a form of diversification because they own servers and software!

They think that having Pfizer (PFE:NYSE) , Bristol-Myers Squibb (BMY:NYSE) and Procter & Gamble (PG:NYSE) makes them safe!

And as much as I like the oil stocks, I can't countenance a portfolio made up of ExxonMobil (XOM:NYSE) , Chesapeake Energy (CHK:NYSE) and Halliburton (HAL:NYSE) .

An undiversified portfolio is not just an amateur mistake, though. Many professionals don't like to be diversified because of the bizarre way money is run in this country. If you concentrate all your bets in one sector and the sector takes off, you will beat pretty much every diversified fund out there. That's the nature of the beast. You then can market yourself as a huge success and get profiled by every magazine and take in capital from unsuspecting folk who don't know how much risk you truly are taking on.

Both amateur and professional are wrong; controlling risk is the key to long-term rewards and controlling risk means being diversified at all times.