| Battle Boredom with Small Cap Stocks By Stephen J. Butler |
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Battle Boredom with Small Cap Stocks
By Stephen J. ButlerArchives
Tom Wolfe, the
novelist, pointed out in a recent essay that kids who supposedly
have attention deficit disorder (ADD) have no trouble playing
SEGA video games for hour after hour. These kids (99% are boys)
may pose problems for teachers and parents, but Wolfe suggests
that the issue is not caused by an inability to concentrate. Speaking
for an earlier generation, Johnny Carson described his problem
as one of having "a low threshold of boredom."
Boredom is a real factor for investors. The stock market of the
2000s has lost the entertainment value and stimulation it provided
in the 1990s. It was marvelous fun to invest in Cisco, Lucent
or a growth-oriented mutual fund--or even an S&P 500 Index
fund--and watch these investments double and triple over short
periods of time.
Now, we can barely stand to open the statement envelopes or boot
up the computer to check our balances. The only funds doing well
are the same value stocks we shunned back when they were losing
money and their managers were being ridiculed or fired. There
were articles suggesting that the ultimate value investor, Warren
Buffett, had "lost it" and that he "didn't get
it" when it came to the new economy.
Value stocks
are indeed boring. The investment world's answer to ice fishing
leaves us fidgeting in our seats. Value investing means locating
companies that have hidden value and then waiting, sometimes years,
for a stock's price to rise. Buffett has said that his ideal holding
time "is forever."
People leaving jobs often leave their retirement money back with their former employer. The thinking is that the money is safe and moving it entails one more decision at an otherwise stressful time. In most cases, however, leaving money in a former plan can be a mistake. Copyright
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In contrast, growth stocks seemed so exciting. They offered instant
gratification because you were effectively a "momentum"
investor. You bought a stock because it was already going up in
value. This created a self-fulfilling prophesy. Professional investors
of the growth investment style persuasion had screening software
that would identify the same fast-moving stocks and the feeding
frenzy was launched. Herman Melville, in Moby Dick, describes
how sharks eat captured whales by taking bites "the size
of human heads." The analogy fits our more recent experience
with growth stocks.
Those who long with nostalgia for the better times of growth stocks
will likely find it first in the small capitalization company
arena. Small companies traditionally have lead the market out
of declines because they can outmaneuver larger organizations.
Small companies can cut back expenses quickly when times are tough.
There is a greater cause and effect relationship between employees
and the product or service for sale.
In large companies, by comparison, the situation was described
best in the 1950's-era classic, The Man in the Gray Flannel Suit.
The prevailing fear in the life of a large company manager was
the discovery that he (and they were almost all men) didn't do
anything of value. GE's Jack Welch made the fear come true when
he insisted that all GE departments fire the least valuable 10%
of their employees each year.
In establishing what became the most difficult career demand for
surviving managers at GE, Welch made the company an engine of
success. Companies like GE and Tyco International have demonstrated
this ability, but most big outfits lack the organizational discipline.
A director of a major paper company once dismissed the success
of a competitor by saying, "All that those people care about
is profits."
In smaller companies, the cause and effect between employees and
profits is hard-wired. Lacking that sea of money on which big
companies float, small companies have dramatically less margin
for error. This explains why small cap stocks historically have
lead the stock market out of a decline. In just the past month,
as a matter of fact, small company mutual funds have increased
by about 5%.
The stock market historically has lead the economy out of a recession
by an advance of about 6 months. As a predictor of economic peaks,
the stock market leads by about 9 months. These cyclical relationships
between stock prices and economic activity can be traced back
to as early as 1913, which makes them reasonably well established.
If you are bored with market performance and looking for a return
to the stimulation of the Roaring '90s, it may be time for moving
money into a selection of diversified small-company stocks. These
are the ones that have taken the biggest beating over the past
eighteen months. The cyclical trends are in their favor. Also,
they offer an opportunity for those investors who re-balance their
portfolios periodically. These small company investments, if we
had them at all, now command a smaller percentage of our portfolios
than when they enjoyed so much attention at the end of '99.
Re-balancing, remember, is a form of dollar-cost averaging. To
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Losing Your Job? What About Your Retirement Account?
By Stephen J. ButlerArchives
First, the fees in the old plan may be substantially more than you would pay after rolling the money over into a rollover IRA. Many plans, especially those offered by vendors to smaller companies, pass costs on to participants in the form of higher asset charges. They can be as high as 2% or more. In the past year of mutual fund losses, this just adds insult to injury. Avoid these charges by moving to a good financial institution that offers discounted fees or inexpensive no-load funds.
The quality of your investment choices expands dramatically if you move to your own IRA. You can invest in any stock, bond, or mutual fund sold in the U.S. Most retirement plans have limited selections for practical reasons, and many of these selections were chosen originally because of great results over the years prior to 2000. As a result, there are not that many value-styled funds in a typical 401(k) plan. A plan sponsor choosing funds for their plan five years ago would have seen value funds with flat results compared to growth funds with 20% or more returns. In one case I am familiar with, employees with a combined total of $3.5 million had chosen the value fund for only $234 of their assets. That fund was up 24% in 2000 while the ever-popular Janus funds, with most of the remaining money, had major losses for last year. Plan sponsors can't be blamed if they offered diversity that prompted little interest on the part of employees.
But that was then. This is now. If your retirement account has suddenly morphed into money you now have to use for living expenses, you may want to move some of it into a money market fund or a short-term bond fund. This will avoid exposure to the next financial jolt. Getting back to the basics, you'll recall that long-term money was best invested in the stock market. Short-term money that may be needed within five to seven years should be in a fixed-income investment. Suddenly, at least a portion of your long-term objective may have become a short-term objective.
Rolling funds to an IRA also avoids the mechanical problem that can occur when a company is imploding. Often, the trustees of a plan are a few senior executives who are out the door with everyone else. The plan becomes like a ghost ship with no one at the tiller. The money is safe, but for the time being there is no one to legally disburse it. The directors need to appoint a new trustee, but they may be preoccupied in acrimonious debate regarding the fate of the company and what's left of their investment. Your 401(k) account balance is the least of their concerns.
If you are one of those people who have recently been asked to leave the premises with your personal belongings in a box, the message should be clear. Take a few minutes before leaving to complete whatever paperwork is required to process your distribution. Follow up repeatedly until you see the money appear in your rollover account.
Remember, when you're between jobs, your retirement money may be a critical contributor to survival. You can access portions of this money at any time, and the only cost is the 10% penalty and regular income tax on the amount you spend. If you are unemployed for a major portion of the year in which you take the distributions, this could be the only income you have that will be subject to taxation. The tax on the first $20,000 of income for a single person is only about $2,500. The total cost, including the penalty, will be $4,500.
So, if you are headed back to college or graduate school for a year or more, this may be the only income you have. If you want to take time to find the perfect next job, your retirement money may provide you with that luxury.
It's not a sin to tap your retirement money, but it is a bummer. It is very expensive to remove money from a program where it could be compounding for years on a tax-deferred basis, so the need to do this should be weighed very carefully.
When filling out your instructions for the distribution, always insist on a direct deposit into your IRA. Never accept a check made out to you personally. This triggers the 20% tax withholding which might otherwise make it impossible for you to deposit the full value of your distribution into a rollover IRA. If 20% is withheld, you would have to find the 20% from somewhere else to make the full deposit. A year later, you may get the 20% back, but this doesn't help you during the 60-day period during which you have to deposit your distribution into an IRA to avoid the taxes and penalties. Money sent directly to your IRA avoids this problem entirely. Therefore, even if you plan to spend some of the distribution, it makes sense to roll it to the IRA first.
You can always access your money on a moment's notice once it is in the IRA. You control the situation and you are not held hostage by circumstances back at your former place of employment.
If you are an older employee with a substantial account balance, the message here is more on the advantage of better investment choices with control over your costs. Leaving, say, $200,000 in the wrong expensive plan could easily be costing $3,000 in annual fees, (the 1.5% cost of many 401(k) investments.) Instead, some good index funds or some bonds in your own IRA might only be costing $240 and generating far better results.
What if you are over age 59 and one half and still employed but you think your company may have a reason to let you go? You might consider moving your retirement money to an IRA now, rather than waiting until you leave or retire. This is an option in most plans, and you would consider this step for all the reasons cited above. As you continue to work, you would continue to make deposits into the company plan, but roll the for earning an average of 10-12% over time rather than 3% in a risk-free money market fund. There is no free lunch. If there IS a market timer who will remove that risk for the cost of an annual letter, it is impossible to know, prospectively, which one of the many contenders is capable of beating market averages. Let's acknowledge our vulnerability and summon up our resolve to stay the course and stick to the basics.
BUYandHOLD does not recommend any securities. The securities mentioned above are being used for illustrative purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy. The securities markets are subject to the risks of fluctuating prices and the uncertainty of rates of return and yields inherent in investing and past performance is no guarantee of future results.
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