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What investors can learn from stocks' dive, rebound


DEAR FRIENDS: Will someone please tell me what happened to our date with the end of the world?

About 16 months ago, the Asian currencies came unglued. In January, small U.S. stocks started their unhappy slide. The Dow Jones industrial average peaked in July, then plunged almost 20 percent. Russia defaulted on its debts, and world bond markets choked. On any TV channel, you could hear doomsters in full howl.

What a difference two months make, since stocks began their strong move up. The Asian economies appear to be stabilizing. Japan announced another reform plan. Except for Brazil, the big Latin American countries were always in good shape, and Brazil just got a bailout loan.

In the United States, business profits haven't faded nearly as much as analysts feared. The Federal Reserve and central banks in other countries reduced interest rates. All the world's stock markets have been bouncing back. Recently, the Dow hit a new peak.

If you call the slide a bear market, it was the shortest in history, with the fastest-ever recovery from a 20 percent decline. The doomsters are off, the optimists are on.

What have we learned from this make-believe brush with the bear?

Buy-and-hold still makes investment sense, although it's remarkably hard to do. When bad headlines blare and stocks spiral down, you can't help but wonder whether, this time, the music is going to stop.

You were rewarded because the market bounced right back. But we still don't know whether investors would hold the faith in a market that dropped 40 percent over a year or more.

Market timers often lose. If you panicked and sold part way down the slide, I'd guess that you weren't quick enough to reinvest before stocks shot back up. Now you're sitting on your money, wondering if it's too late to buy. (For long-term investors, it's never too late.)

Buying during crashes works. If you'd bought an index mutual fund after the Dow's 512-point drop on Aug. 31, you'd have done beautifully (an index fund follows the market as a whole). If you'd bought an emerging market mutual fund after the Russian default, you might have been up 27.6 percent (that's the average gain since Sept. 11, according to Lipper Analytical Services in New York).

You never know where the bottom is when you buy into a market slide.

This is where dollar-cost-averaging shines. Put a fixed sum per month into a representative mutual fund, as long as the headlines scream bad news. When the story fades to an inside page, sit back and wait for another "bad news" opportunity somewhere else.

Buying crashes is easy to advise, of course, but emotionally hard to do. You rarely get rewarded as fast as you would have been this year.

Buy stock funds during any financial crisis. To counter the crisis, the Fed cuts interest rates and lets the money supply grow. The extra money finds its way into stocks.

That's what happened after the Continental Illinois bank

collapse, the 1987 market crash, the Mexican peso crisis, the Southeast Asian currency crisis and the Russian default. Like any rule, this may not always work. But, so far, so good.

Save more money. Right now, you're letting the stock market "save" for you, by raising the value of your 401(k).

In September, Americans spent more than they saved for the first time since 1933, says Irwin Kellner, professor of economics at Hofstra University in Uniondale, N.Y.

But stocks won't always bail you out. You shouldn't build so much debt and spending into your life that you couldn't resume saving if you had to.

The optimists still hold the floor. The United States continues to clock the longest expansion seen in peacetime, beating the upturn of the 1980s. If business maintains its advance until February 2000, this will turn out to be the longest upturn ever recorded, beating the 1960s' guns-and-butter expansion during the Vietnam War.

But optimists have to be careful, too. "There may be more problems out there than we know about," Kellner says.

He ticks off some possibilities: no further interest-rate cuts; bad news from Iraq; an unsettling impeachment trial; another major financial crisis; higher layoffs that dunk consumer spending and knock the economy down.

Smart investors will use their current good fortune to protect their standard of living.

Prepay your mortgage. Hold some cash. Own good insurance. In middle age, own some bonds.

With your life secured, you can buy any stocks you want.

Washington Post Writers Group

Pub Date: 12/07/98

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