Personal Finance: 2000: Year of the great ‘tech-wreck’

How bad was 2000?

The 39.18 percent drop in the tech-heavy NASDAQ was the worst annual decrease on a major market index since 1937. In a word: awful.

About a year ago — as chance would have it — I spent an evening at the kitchen table with a new client. We’ll call him Bud because he’s the kind of guy who has a lot of friends. Bud’s a conservative, long-term investor about to retire from running his own business.

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For the past five years his portfolio enjoyed exceptional market returns, but we were both apprehensive about the future. Bud, like many investors, entered 2000 with both of the following problems:

1. A portfolio over-weighted in stocks, with not enough bonds in the asset allocation.

2. The stock portion of the portfolio over-weighted in technology.

Asset allocation refers to a portfolio’s mix (much like how a pie is sliced) of asset classes. In the simplest terms, asset allocation usually refers to the percent holdings of stock, bonds and cash. Bud’s asset allocation was 95 percent stocks, 5 percent bonds — remember, he is a conservative growth investor, not aggressive. Five years ago he may have been closer to a 70-to-30 stock-bond ratio but, like many investors, two circumstances led him to an overly aggressive asset allocation:

* Growth of stock allocation through good returns.

* New money to portfolio going into stocks.

As we began the discussion Bud asked the question I’ve heard a hundred times in recent years: “Why would I want to invest in bonds if we know historically they offer a lower average return?” He had no motivation to adjust his asset allocation annually back to 70/30, because stocks had performed well and, “if it isn’t broke, don’t fix it.”

Fortunately for Bud, we decided not to wait for the market to break and shifted his allocation by selling stocks and buying bonds with the proceeds. We determined he would be more comfortable with 70 percent stocks and 30 percent bonds. More specifically, we sold technology stocks and bought tax-free Colorado bonds.

Now that the market has broken, Bud has two questions for me:

Q: What is the result of the changes?

A: Owning more bonds cushioned his portfolio in the NASDAQ downturn. It didn’t keep it from going down, but his portfolio is down 12 percent from its high instead of 18 percent.

Q: What action should I take now assuming the worst is over?

A: He has choices because he owns bonds. Many of his bonds have either held their value or are at a profit. The investor who only owns stocks typically lacks the liquidity necessary to take advantage of low stock prices. So the investor who owns bonds can either sell bonds to buy stocks at low prices or let the allocation go unchanged.

So once again, why invest in bonds if your goal is long-term growth? They cushion the downside of a portfolio and they often go up when stocks go down to offer profits and liquidity at times of low stock prices.

Bud’s second problem of having too many tech stocks is more subtle. He didn’t get any help when we found some of his money managers were drifting from their original investment style and chasing the hot tech-stock market.

It appeared that not only had Bud become overly enamoured with popular tech-stocks but so had the professionals. Portfolios that previously held 20 percent tech were now 40 percent tech. Bud came to the realization that it’s financially healthy to ask yourself once a year, “What do I own?” and “Do I own too much of it?” As a result, Bud moved money from these portfolios to ones that still fit his comfort levels.

Clearly, many investors wish they would have adjusted their asset allocation and exposure to the technology sector just as Bud did. But what if you still have a 95 percent to 5 percent asset allocation, your portfolio is down 18 percent instead of 12 percent and you don’t have much cash to add? Bud’s portfolio is the exception, not the rule. It’s also possible that now may be a better time to buy these NASDAQ stocks rather than sell them. The next time you hear people wondering why anybody would own a bond, maybe you’ll remember to evaluate your asset allocation.