Crash of ’87 Reveals Lessons for Owning Mutual Funds

Investors are a lot smarter then they were when the market lost one-third of its value over three days in October of 1987. The lessons they learned about mutual funds still help investors today.

Chuck Jaffe from MarketWatch discusses four main lessons for owning mutual funds that were learned from the ’87 crash. What I like about the four main points is that they all relate to the mindset of the investor. When emotional trading is intact your ability to make clear decisions is hindered.

From MarketWatch’s Chuck Jaffe:

Their funds are not going to zero

Between falling stocks and the uncertain future of financial services companies, many 1987 investors were worried that their fund or management company was on the verge of going belly up and taking their cash with it.

Your shares in a mutual fund, of course, represent ownership in all the issues held by the fund. If the management company were to go bankrupt, it doesn’t have a claim on the assets; a new manager would step in to run the fund. So long as all of the underlying holdings still have value, so do the investors’ shares.

Knowing that a fund is a reflection of what it owns, rather than an operating arm of the management company, had a dramatically calming effect on investors.

You can’t avoid short-term pain

In 1987, many investors tried to sidestep Black Monday by moving into international funds. After the market had lost more than 4% on each of the two days leading up to the crash, some newsletter editors were suggesting going offshore with the money.

That move helped them miss the pain on Oct. 19. Instead, they got hammered a day later.

Investment pros talk about buying “noncorrelated assets,” securities that don’t all move in sync, so that you can be properly diversified. It’s a wise move, but if the market — any major world market — is having a meltdown, all segments are going to feel some short-term pain.

Diversification and asset allocation allow you to endure longer-term pain

Prior to Black Monday, mainstream investors thought they were getting diversification by investing in a fund or two. The fund was diversified so, by extension, the owner had a diversified portfolio.

Asset allocation was the stuff of academics and high-brow financial-planning conferences, not the concern of every investor with an individual retirement account. Investors understand today that the way to live through market volatility is to embrace different types of risk, spreading money into various kinds of assets; it allows them to stay calm in the face of those short-but-broad market swings.

One day, even a record bad day, does not make the difference in a lifetime of sound investing

The Black Monday anniversary coincides with the front edge of the baby boom generation qualifying for Social Security benefits. No one got to this point and said “Shoot, I could have retired today had it not been for Black Monday back in ’87.”

Few days on the market will be as memorable as Oct. 19, 1987, but even the days that inspire the most nervousness will not be remembered when it comes to counting up your nest egg after the appropriate passage of time.

Discipline and staying calm are the keys to success indeed.

Source:
Fund Lessons From the Crash of ’87
Chuck Jaffe
MarketWatch October 22, 2007

http://www.marketwatch.com/news/story/mutual-fund-lessons-crash-87/story.aspx?guid=%7B7A8A875F%2D096F%2D46F9%2DA695%2D2689CA5ED9AD%7D

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