A Lesson Before Buying: 2000 Taught Us a Tough but Familiar One

Picture a steel-gray Ford Taurus passing a cherry-red Ferrari that's curbed with its hood up, and that gives you a good impression of the market this year. If last year belonged to the tech bulls, this year surely belonged to the meeker asset-allocator types who are content to spread their money around.

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Last year and in 1998, tech funds and tech-heavy growth funds rode the sizzling sector to jaw-dropping gains. Not surprisingly, investors flooded these funds with cash. But slowing economic growth, precariously high valuations and the resultant investor jitters hit tech hardest, clocking its biggest fans, too.

So what did this tough year teach us?

For one thing, if we're in a New Economy or a new era, the rules don't seem that different from the not-so-distant old one. Every once in a while, exaggerated excitement creates a bubble that inevitably draws a lot of money and then bursts -- witness the (JAMFX Quote)Jacob Internet fund's breathtaking 79.1% loss this year.

The lesson for the year 2000 is a simple one. While it may seem obvious now, it certainly didn't to many at the beginning of the year: For most investors, a diversified portfolio makes the most sense. Call it comeuppance, call it portfolio indigestion -- we saw it this year as 1999's stars flamed out.

Last year the average tech fund rang up a 136% gain, but this year it's the worst-performing U.S. fund category, down more than 33% and some 39% in the fourth quarter alone, according to Morningstar. With a week left in the year, 15 of the 25 worst-performing funds since Jan. 1 are tech funds. And techlike telecom funds, which posted a 65% return on average last year, are down 33%, too.

In fact, only health care funds -- buoyed by the biotech sector -- have kept last year's pace with six of the year's top 10 funds. At the same time, investors rushed to cheaper, more defensive sectors like natural resources, real estate and financials, sending funds focused on these sectors north. (Remember last year when we told you real estate and financial-services funds were probably due for a solid year?)

Good Health, Bad Tech Here's a list of fund performance by category, this year and last
Sector Fund Category	YTD	1999
Health care	49.2	19.4
Natural Resources	23.2	30.5
Real Estate	23.8	-3.4
Financial Services	23.7	-1.3
Utilities	3.5	28.4
Communications	-33	65.0
Technology	-33.3	136.0
S&P 500	-10.2	21.0
Source: Morningstar. Performance through Dec. 22.

These shifting sands among sectors rippled through diversified stock funds, too. Growth funds essentially buy stocks of companies with the highest projected earnings growth, while value funds are Wall Street's bargain hunters, typically buying stocks of slower-growing shops that the market is ignoring. Consequently, the average growth fund has more than 40% of its assets in tech stocks -- more than twice the tech bet of value funds, which tend to have decent stakes in financial stocks.

Those tastes led to a comeback for value funds, which makes sense, because historically growth- and value-investment styles trade leadership every few years.

2000: A Stunted Growth Odyssey
	Growth	Value
Large-Cap	-15.2%	2.6%
Mid-Cap	-9.9	12.7
Small-Cap	-10.9	11.8
Source: Morningstar. Performance through Dec. 22.

Among the 10 biggest stock funds in the nation, six are growth funds, and of those six, only the $36.1 billion broker-sold (AGTHX Quote)Growth Fund of America is in the black on the year with a 2.6% gain. Giant tech-heavy growth funds like the closed $39.8 billion (JANSX Quote)Janus fund, down 17.9%, and the $33.7 billion no-load (TWCUX Quote)American Century Ultra, down 23.3%, haven't fared as well. (For more on Janus' tumble this year, check out our Janus Speaks! package.)

Arguably, there wasn't much you could do to completely sidestep this year's pain. The no-load (VFINX Quote)Vanguard 500 Index fund and the no-load (VTSMX Quote)Vanguard Total Market Index fund, which track the S&P 500 and the Wilshire 5000 indices, respectively, are down 10.1% and 12% on the year. But sticking with cheap, broad funds like these or using them as core holdings along with more aggressive growth funds would've reduced losses.

For hard-core growth investors, buying an index fund might feel like a cop-out, but that doesn't actually make much sense. That's because over the last 10 years, big-cap growth funds and the S&P 500 have the exact same annualized return: 17.3%. In real-world terms, $10,000 invested in the average big-cap growth fund or the Vanguard 500 Index would've grown to about $50,000, according to Morningstar.

This year also shows why we're always told that every investor should put some of his or her money in bonds or bond funds. This year the average intermediate-term bond fund gained 9.8% and the no-load (VBMFX Quote)Vanguard Total Bond Market Index fund, which tracks the Lehman Brothers Aggregate Bond Index, posted an 11.7% gain. We've recently made the case for owning bonds.

Owning international stock funds is usually a big part of the diversification argument, but that didn't work out too well this year. The average international stock fund fell more than 19%. Still, the long-term argument that a modest position in foreign stocks can boost a domestic portfolio's returns and reduce its risk still holds true.

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I'll be out on vacation this week, slacking in Manhattan's canyons and finally finding some extra time to spend with friends and Pam, my own version of the Trading Goddess. I wish you all a happy, healthy and wealthy New Year. Whether the market heads up, down or sideways, one of my resolutions for 2001 is to help you cut through the hype and keep your portfolio comfortably on target.