The woeful wait to break even
By Paul Merriman
CBSMarketWatch
Last Update: 12:04 AM ET March 6, 2002
SEATTLE (CBS.MW) -- Every experienced investor has suffered losses, and most of us have wished at one time or another we could only get back to "break-even" status so we could start out "whole" again.
But breaking even isn't what it's cracked up to be. In fact, it can be a trap.
Ernest of Eugene, Ore., may have a long wait ahead of him. He wrote to say that a year and a half ago, on the advice of a popular financial radio show host, he put one-third of his portfolio into the QQQ tracking stock, essentially an exchange-traded fund that invests in the Nasdaq 100 Index ($NDX: news, chart, profile). "I can't bring myself to sell this until I break even," he said.
In this case, breaking even is a pretty tall order. This reader's $400,000 investment in QQQ (QQQ: news, chart, profile) is now worth about $150,000. That means he has a 62.5 percent loss. To make up that loss and break even, his investment must go up by 167 percent.
Plenty of investors are in similar straits after two terrible years for technology stocks. Should they hang on and wait for their stocks to come back? Or should they take their losses and lick their financial wounds?
There are three possible solutions to this dilemma:
First, Ernest can stay the course with his QQQ and wait. There's no telling how long this could take, but it might be many years. If Nasdaq stocks appreciate in the future at a steady rate of 15 percent, this investment would "come back" to his break-even point in seven years.
Depending on what happens in the market, the break-even point could happen in only half that time, or it could take 10 or 20 years. There is just no way to know. And along the way, what's to stop the QQQ from falling once again by 50 percent or more?
Second, Ernest can sell the QQQ and invest in an asset class other than technology stocks that has similarly high risks and the potential for high returns.
One likely candidate is U.S. small-cap value stocks. From 1972 through 2001, a U.S. small-cap value stock index tracked by Dimensional Fund Advisors had an annualized return of 17.5 percent, compared with 11.8 percent for the Nasdaq Index. One good way to participate in this market is through the Oakmark International Small-Cap Fund (OAKEX: news, chart, profile).
Past returns are only in the past, of course, and here again there is no way to know how long it might take Ernest to break even in small-cap value stocks.
Third, Ernest can give up on trying to figure out what asset class is going to do best in the near future and properly diversify his remaining $150,000. That means evaluating his risk tolerance and making sure his investments include funds that invest in U.S. and international large-cap, small-cap, growth and value stocks.
This approach is not likely to build $150,000 back up to $400,000 any time soon. But neither is it likely to subject this money to another decline of more than 60 percent.
Just as important as choosing the right option, Ernest should think carefully about two issues: the concept of waiting to break even after a loss and the advice on which he relies to make his investment decisions.
Investors pay a lot more attention than they should to the issue of "breaking-even." Except for income tax purposes, breaking even is pretty meaningless. It just doesn't matter any more that an investor paid $400,000 for something. The market doesn't care. Potential buyers for QQQ shares don't care. Nobody at all cares, except the investor himself.
Yet investors can become obsessed with breaking even as if that had real meaning. They may realize they made a big mistake, and they may be itching to sell an investment to do something they believe will be more productive with their money. But because they "can't bring themselves to sell" at a loss, they remain invested in an asset they don't want to be in and they can't have that money invested the way they think it should be invested.
This stubborn approach does investors no favors. Ironically, the time they spend waiting costs them the opportunity to do the very thing they are eager to do: invest in something else.
The second issue this reader should think about is the source of his investment decisions. Ernest said he invested in the QQQ solely on the basis of a radio show host's opinion that late 2000 was "the time to get back in" to technology stocks.
If an investor wants to rely on such recommendations for 5 to 10 percent of the investments in a portfolio, that's no problem. But it is reckless and irresponsible to commit a third of one's life savings on such a whim.
Perhaps the best advice I could give this reader is very ironic: Don't take my advice. By that I mean don't do something only because I say you should do it.
Don't make major investment decisions without knowing what you're doing, why you're doing it and what might go wrong. Don't invest until you can do so as part of an overall strategy -- and until you understand that strategy well enough that no radio show host can talk you out of it.
Paul Merriman is founder of Merriman Capital Management in Seattle, and is editor and publisher of FundAdvice.com. |
