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Portfolio > Economy & Markets > Stocks

Common Sense Triumphs

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S&P 500 Index-2.74%-2.74%-2.74% Large-cap stocks

DJIA-3.45%-3.45%-3.45% Large-cap stocks

Nasdaq Comp.-1.09%-1.09%-1.09% Large-cap tech stocks

Russell 1000 Growth-2.43%-2.43%-2.43% Large-cap growth stocks

Russell 1000 Value-2.42%-2.42%-2.42% Large-cap value stocks

Russell 2000 Growth-2.72%-2.72%-2.72% Small-cap growth stocks

Russell 2000 Value-2.82%-2.82%-2.82% Small-cap value stocks

EAFE-3.98%-3.98%-3.98% Europe, Australasia & Far East Index

Lehman Aggregate0.09%0.09% 0.09%U.S. Government Bonds

Lehman High Yield3.33%3.33% 3.33%High Yield Corporate Bonds

Carr CTA Index5.18% 5.18% 5.18% Managed Futures

Common Sense Triumphs

They said it would never happen. After swearing on their crystal balls and mood rings, Wall Street’s best and brightest seemed convinced that the stock market couldn’t possibly end lower for the third consecutive year.

How wrong they were. Instead of a recovery, U.S. equities continued to bleed red ink in 2002, marking the first three-year drop since before the Second World War.

The inability of the major brokerage houses to predict the direction of stock prices is hardly newsworthy. After two years of what Morgan Stanley’s chief U.S. strategist calls “off-the-charts forecasting errors,” economists are no closer to determining the next market move now than they were at the beginning of the bull market in 1982. Nonetheless, 2002 marked the end of many false perceptions that investors have been clinging to for years.

One of the most compelling (though blatantly untrue) rules of thumb was the seeming infallibility of large-company stocks. After seeing the first leg of the bear market annilihate small technology concerns, 2002 witnessed widespread carnage among some of America’s biggest corporations. Take General Electric, for example, which lost an astounding $140 billion in market value in ’02, and the demise of Enron and Tyco, both of which were once proud members of the S&P 500 index. Sadly, the lion’s share of these losses was the result of corporate malfeasance. As Aesop once said, “Self-conceit often leads to self-destruction.”

But perhaps the most important lesson of the past year is the tendency of individuals–even those charged with fiduciary responsibilities–to operate first and foremost in their own self-interest. The standard Wall Street business practice of selling investments that benefit the firm over the client was finally brought to the forefront in 2002, though the resulting $1.4 billion fine levied by New York Attorney General Eliot Spitzer will fall far short of the huge losses of these firms’ unfortunate investors.

Investors have been devastated by the three-year-old bear market; many investors are like men on a sinking ship desperately seeking a life raft. And it’s hard to blame them. After all, the investment process is harder now than it ever has been. There are more mutual funds than stocks, and an astonishing 5,000 asset classes from which to choose. Mix in the active versus passive debate, throw in some hedge fund misinformation, add plenty of economic uncertainty, and the result is what individual investors are faced with today. Clearly, the need for objective advice is greater now than ever.

That’s where a quality, unbiased investment advisor fits into the equation. Most RIAs don’t use Wall Street research, and they shy away from placing all their client’s eggs in the same basket. Indeed, most advisors own a little bit of everything–stocks, bonds, and alternative investments–based on a client’s objectives and risk tolerances.

Advisors also function as consiglieri, ensuring that clients don’t sell out of positions at the worst possible time A good RIA brings many things to the table, including independent thought, discipline, risk aversion, and tax awareness.

Of course, most of these attributes are the byproduct of common sense. Nonetheless, this approach can avoid many problems, including the ones above that plagued many investors during the past year.


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