How will you explain your mistake?
Today's Financial News - Posted February 5, 2009
As the nation’s economy sinks and investors react, many traders are making a costly mistake. Decreased risk in one asset does not clear the path to safety in another.
By Andrew Snyder, TodaysFinancialNews.com
Baltimore – (TFN): There is an intriguing trend gaining momentum in the investing world traders must be cautious to avoid. With the nation’s economy taking a dramatic beating over the last six months, investors have been seeking shelter wherever they can find it.
The American treasury market has been the lifeboat of choice for many investors. A year ago, their portfolios may have been comprised of just 20% or 40% fixed-income assets. But now that the nation’s economic future is uncertain, they are sprinting to the safety of risk-free bonds. Many retirement portfolios are bursting at the seams under the weight of 60% and even 80% bond allocations.
Sure, it is smart to take advantage of the safety of the Treasury’s debt, but investors still have an appetite for making money. In fact, many still expect the kind of exuberant gains they have rationalized over the past decade. But with a portfolio built on a smaller-than-normal fraction of equities, they have to take big risks to find any chance of beating the market.
Greed always finds a way
Instead of putting their money into the nation’s strongest and most fundamentally sound firms, profit-hungry traders are turning towards speculative, high-risk assets. The small-cap market is getting more and more attention every day. The trend is getting a lot of investors in trouble.
Take a look at the chart:
The blue line indicating the Russell 2000 (the top small-cap index) is clearly fairing worse than the Dow Jones Industrial Average (the red line) and the S&P 500 (the green line).
The chart proves, at least for the index as a whole, small-cap investors are fighting an uphill battle. Sure, the top ten performers in the index, companies like Photronics (NASDAQ:PLAB) and ACCO Brands (NASDAQ:ABD), have surged by triple-digit proportions over the past few weeks, but they are certainly the exception.
Many of the nation’s smallest companies are suffering great pain as the credit industry contracts. The smaller they are, the harder it is to find the loans they need to survive.
I have to watch my words here. Of course, the entire Russell 2000 index is not filled with losers. Just as the two companies listed above prove, there are plenty of winners in the small-cap arena. You just have to know how to find them.
Instead of using a big bucket to dip into a well of potential winners, you have to sift through them with nothing more than a tiny tablespoon, picking a handful of winners out of a sea of losers.
It may be tempting to adjust your portfolio allocations during a drastic economic downturn like this one. But if you do, you are setting yourself up for failure. A well-diversified portfolio will automatically protect you from the worst of fallout and will magnify your upside once things turn around.
By overweighting the fixed-income and small-cap arenas, you are investing in opposite ends of the spectrum. That means you will get nowhere. Do not make the mistake.
Next Article: Hope and Change in Action: How government-directed business stimulus looks like
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