Lessons of the Nasdaq Bubble

Financial advisers can't emphasize enough the need to diversify your holdings.
By Gregg Greenberg ,

Most of us would probably sooner forget the popping of the tech bubble.

Nevertheless, Thursday brings the five-year anniversary of the all-time peak in the

Nasdaq Composite

. Back on March 10, 2000, the index hit 5048, as hefty gains in highflying favorites like

eBay

(EBAY) - Get Report

and

Rambus

(RMBS) - Get Report

overcame setbacks in hard-chargers

Amazon

(AMZN) - Get Report

and

Yahoo!

(YHOO)

.

Since then, of course, the tech market has suffered through a wrenching correction. And even now, with the Nasdaq having almost doubled off its fall 2002 low, the index remains 60% below its 2000 high.

(

TheStreet.com

also asked Greg Luttrell, manager of the TIAA-CREF Growth Equity fund, to

look back at the bubble and how far we've come since the top of 2000.)

So regardless of whether there's any minibubble forming in the market now, it's worth taking a quick refresher course on how you can avoid the massive losses that countless investors got socked with the last time around.

1. Don't Forget to Rebalance

Rick Bloom, financial adviser with Michigan-based Bloom Asset Management, says one of the biggest mistakes people made during the boom was not rebalancing the assets in their portfolio on a yearly basis.

"The Nasdaq was so good in 1999 that by the end of the year, people's portfolios were grotesquely overweight with technology stocks," says Bloom. "And instead of pruning their positions, they just let it ride."

Bloom partly attributes investors' unwillingness to pay taxes on their gains as a reason why they allowed tech stocks to overrun their portfolios like weeds in a garden.

"The goal is never to lower your taxes but to put money in your pocket," says Bloom.

2. What Goes Up...

The dot-com bust wasn't Bert Whitehead's first encounter with a financial bubble, and the 50-year industry veteran expects it won't be his last.

Whitehead, the president of Michigan-based Cambridge Connection, a fee-only financial planning firm, remembers the public going similarly overboard in the 1950s with uranium stocks, in the '60s with plastics, in the '70s with gold and in the '80s with real estate. His conclusion: "No matter what it is, the hot sector of the decade will inevitably spin, crash and burn because there is too much money thrown at it."

Despite history being against him, Whitehead hopes the memory of the last bubble lingers long enough to enable at least some investors to "steer clear when they see a stock mania approaching."

3. Sell Your Losers

Gary Mandell, financial adviser with the Chicago-based Mandell Group, asks, "How many times does your broker call you with a sell recommendation as opposed to a buy?"

The answer for most investors is hardly ever and, as Mandell points out, it was even less so during the Internet boom, when stockbrokers would encourage their clients to ride their losers down, while finding additional new stocks to buy.

"Psychologically, it's tougher to sell your losers because it's an admission of a mistake," says Mandell. "And stockbrokers and individual investors were loath to admit their mistakes until it was too late."

Don Sowa, a financial adviser with Rhode Island-based Sowa Financial Group, offers a good solution to prevent investors from repeating this particular mistake: "Don't forget about stop losses." A stop loss is an order placed with a broker to sell a security when it reaches a certain price.

"You have to have a mechanism in place to protect you from yourself," says Sowa.

4. Walk On By

Tim Medley, financial adviser with Mississippi-based Medley & Brown, offers a bit of common sense that was often forgotten during the go-go years: If you know a stock is ridiculously overpriced, don't buy it!

"If you wanted to buy a local tire or grocery business, then you would look at their financials and come up with a valuation," says Medley. "If it's reasonable or undervalued, then you buy it, if not, then you just walk on by."

Medley says that with all the online financial tools available for investors, there is no excuse for not knowing if a stock is trading at an unsustainable price-to-earnings multiple, for starters.

"You need to put the time into researching the stocks you buy," Medley says. "It's not as easy as listening to your neighbor for the latest great stock tip."

5. Don't Forget to Diversify

"Trying to get people to diversify back then was like pulling teeth," says Deborah Voso, financial adviser with Maryland-based Voso Associates. "I remember making a presentation to five AOL executives at the time who were loaded with AOL stock and I was pleading with them to diversify into bonds."

So what happened?

"Only one of them did. And he's loved me ever since," says Voso, adding that she has found it less necessary to "pull teeth" to get her clients to diversify since the bubble's collapse.

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