Huge market tumble may reveal fissures in investor's strategy

YOUR FUNDS

March 06, 2007|By CHARLES JAFFE

If you've ever been the parent of a teenager, you know that it's a bad idea to read too much into any single day. When your normally angelic kid has a devil of a day, it's important not to overreact and to see if the behavior is an anomaly or the start of a trend.

That same kind of thinking typically can be applied to the stock market and mutual funds.

So when the market had its biggest down day since September 2001, and the eighth-biggest point drop in the history of the Dow Jones industrial average, the standard advice was to push on.

But just as a watchful parent looks for clues during those peak days for what sets their children off, so should the diligent investor look at the market's move last Tuesday to see if it holds any hints that could lead to long-term happiness or disappointment.

Experts are virtually universal that one day's movement, no matter how large, is no reason to abandon a fund or investment strategy. Instead, the key things to look for are more subtle.

Here are questions investors might want to answer in light of last week's market stumble.

Were you glued to the television and gulping antacids?

Staying calm during swift, sudden market moves is all about risk tolerance.

"If you were inordinately worried about the market activity on Tuesday, you may be tiptoeing on the edge of your risk scale," says Christine Benz, director of mutual fund analysis at Morningstar Inc. "Your mix of funds - rather than any individual fund - may be the problem."

Play some "market trauma what-if," seeing how your performance might have changed by adding one or two diversifying funds to the mix.

Did the day's volatility stress-test your fund?

Many people checked their investments after Tuesday's carnage, but didn't compare their funds to peers, and the side-by-side look is a big deal.

"If you have a large-cap value fund that went down a lot more, or a lot less, than the large-cap value index, you have to wonder if the fund is doing what it is supposed to," says Roy Weitz, founder of FundAlarm.com, a Web site which helps consumers decide when to sell funds. "If your international fund performed more like an emerging markets fund, it suggests that the fund is drifting toward those markets, and those risks.

"If the results compared to a benchmark are a surprise, you may want to re-evaluate the fund when you get the next quarterly or semi-annual statement of the portfolio holdings, to see what the fund really holds and if it is in line with what you thought you were buying."

If you didn't bail out, do you really want an instant parachute?

This applies to investors in exchange-traded funds, or ETFs, which are built like index funds, but which trade like stocks. One key selling point for ETFs has been the idea that investors can get out of the market on a moment's notice. Critics, including Vanguard Group founder Jack Bogle, have suggested that investors might dump their index strategies any time the market hits the skids.

Last Tuesday was the first true test of will for ETF investors. Exchange-traded funds weren't used much by mainstream investors back in 2001, the last time the market had a day with this much movement.

Early volume statistics suggest that ETFs traded like crazy on Tuesday, but most observers believe the action was institutional investors following technical, short-term models. If average investors who use ETFs stayed put, it raises a simple question: "If you're not using the instant egress for moments like this, when will you use it?"jaffe@marketwatch.com

Charles Jaffe is senior columnist for MarketWatch. His postal address is Box 70, Cohasset, MA 02025-0070.

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