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Many investors these days have truly short-term memories. They seem to be driven by yesterday's and last week's market events, conveniently forgetting the lessons of last year and the years before that.
Thanks to the market's stellar 55% rebound since last March, a good number of investors have been jumping back on the gravy train, convinced that the downturn is behind us and that nothing but sunny days are ahead for the market. But as one prominent shop has recently pointed out, investors who think the market is headed down easy street may find their road taking a sharp detour.
Taking the air out
Mutual fund giant Vanguard recently issued a warning on its website, urging investors to view the third quarter's strong results as a yellow flag. The fund company cautioned investors to take the recent rally in stride and not rely on hot performance to continue. Pointing to several of Vanguard's own funds that have rebounded strongly in 2009, the warning argues that you shouldn't use short-term performance to judge a fund's long-term prospects.
There's no denying that Vanguard has had some strong-performing funds this year. Vanguard Capital Value (VCVLX) is up nearly 68% this year, fueled in part by stellar performance from energy holdings like Petroleo Brasileiro (NYSE: PBR ) , CONSOL Energy (NYSE: CNX ) , and Walter Energy (NYSE: WLT ) .
You'll also find Petrobras in the Vanguard Emerging Markets Stock Index Fund (VEIEX), which also includes China Mobile (NYSE: CHL ) and Sasol (NYSE: SSL ) among the stocks in its portfolio. A 65% rise so far this year has many looking at emerging markets as potential protection against a falling dollar.
Similarly, the Vanguard Precious Metals & Mining Fund (VGPMX) has cashed in on increased interest in precious metals, rising more than 60% in 2009. Many of its holdings have done extremely well, including BHPBilliton (NYSE: BHP ) and Eldorado Gold (NYSE: EGO ) .
A two-fold message
Of course, part of the motivation behind this public service announcement is self-serving -- Vanguard knows that investors are notoriously short-sighted and will throw money at funds like these that have racked up high-flying gains in a short time period. Unfortunately, they'll also be the first ones out the door once those same funds stop appearing at the top of the charts. So this warning is a completely reasonable proactive move to warn investors that these funds aren't likely to continue their recent hot performance.
But there is a larger message here that investors should take away. The stock market has come a long way in a short period of time. It's completely possible that the rebound has gone too far, too fast. After all, considering the gigantic crisis our economy has endured, it's likely that investors oversold on the downside and may now be overbuying on the rebound. Anyone who thinks that the sailing is clear from here on out may be in for a shock -- especially those who are doubling up their bets on the market to make up for lost money!
Back to basics
So what can long-term investors do? No one wants to lose more money after the events of the past few years, but neither can anyone afford to miss out on more of the rebound.
While it's not sexy advice, one of the best things investors can do is maintain a diversified portfolio and stick to their long-term investment plan. It's been said that diversification is the only free lunch when it comes to investing, so don't pass up this free meal!
Never try to make up for lost ground by betting heavily in one sector or area of the market -- there's no telling what the market will do, so spreading your bets across sectors is the safest move. In addition, don't chase performance and pile into whatever funds have racked up the best gains this year -- Vanguard is correct in saying that hot markets eventually cool, and most investors don't catch on until it's too late.
There may be a correction in the works, but because I can't tell exactly if or when that is going to occur, I'm not going to try to time the market -- and neither should you. After all, history has shown that most investors are lousy market timers.
Make sure you've got a good, solid asset allocation plan and stick to it. Investors should be mentally prepared for a correction or even just slower returns in the near future. But by keeping a long-term focus and sticking to your game plan, you'll end up ahead of the herd-following pack. And I think that's advice that even Vanguard would endorse!