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Nasdaq 2000: Lessons Learned

What once might have sounded like a futuristic slogan -- "Get Ready for Nasdaq 2000!" -- now represents a new low point for the so-called "tech-heavy" Nasdaq index, which quickly fell below the 2000 mark this morning for the first time since December 16, 1998. Former high-fliers such as Cisco Systems (Nasdaq: CSCO) and Ciena (Nasdaq: CIEN) continued to bring the pain, with Cisco announcing layoffs late last week, and Ciena off 15% thanks to a warning from fiber optic components company Oplink Communications(Nasdaq: OPLK), and other pressure on the fiber-optic sector.

Perhaps it's fitting that this new low comes on the first trading day after the one-year anniversary of the Nasdaq's all-time high, which was reached on March 10, 2000, when the index closed at 5048.62. As of Friday's close, the index was down 59.3% since that date.

We asked our writers a few questions about this decline, and what impact it has had on their investing strategies. Among other things, we asked about diversification, buying and holding, and general lessons.

How have the events of the past year affected your approach to investing?
Jeff Fischer
(TMF Jeff on the discussion boards): The Nasdaq's decline reminds me that I should only buy companies that I would be willing to hold through a steep market downturn. That means buying companies that I understand to a point of great comfort.

When you understand a company, you can "understand" a stock price decline, too. You can also understand (because you see it happen!) how a company's business and its stock price can be very independent of one another for periods of time, depending on the market's mood. I've only owned businesses that I understand during this decline, and so it has been much easier to stomach. It hasn't been fun, but easier. Meanwhile, I should get outdoors more often!

David Marino-Nachison (TMF Braden): With a clean balance sheet and a retirement account flush (by my humble standards) with index funds, I took my first plunge into the world of stock picking last March with three small, experimental investments of a few hundred dollars. I selected three stocks: a strong retail company I felt had fallen to can't-miss valuations, an-almost-Rule Maker in a sector about which I felt very knowledgeable, and a high-flying Internet "story stock."

Care to guess which of the three doubled, which appreciated by about 30%, and which one has seen its market value evaporate to nearly nothing? Though I made some money on my first three picks, I've no illusions that I'm a superior investor. Actually, the mere fact that I chose perhaps the worst entry point in recent memory tells me I still have plenty more to learn. One thing is certain: I will continue to look for strong businesses in which I believe and which I understand -- and strive to better understand and utilize valuation principles each and every day. Some investors are successful race drivers, no doubt, but I'm perfectly happy getting there a bit more slowly with a minimum of moving violations.

Is there any way for investors to anticipate a top like the one we experienced last March? Should we look at economic indicators, for example?
Brian Graney
(TMF Panic): No, timing the market is just as hard to do this year as it was last year. I still believe in the old Peter Lynch saying that if you spend 13 minutes a year thinking about indicators and the economy, you've wasted 10 minutes. Whether the Fed raises or lowers interest rates this week, this month, or this year tells you very little about how Coke's competitive advantage period is changing or what Wal-Mart's (NYSE: WMT) earnings are going to be five years from now.

Chris Rugaber (TMF Chris): While it's impossible to predict market downturns, I've modified my opinion a bit about the importance of the broader economy. The number of companies -- Sun Microsystems (Nasdaq: SUNW), Oracle (Nasdaq: ORCL), Nortel Networks (NYSE: NT), and Intel (Nasdaq: INTC) among them -- that have reduced earnings and revenue estimates in recent months because of slowdowns in capital spending on networking equipment and information technology (IT) systems is striking. Certainly, I won't be buying or selling solely in response to broader economic trends, but I do think they're worth keeping an eye on, particularly if you're holding companies with great expectations priced in.

Do the events of the past year reinforce the need for investors to "diversify" their holdings?
Tom Jacobs
(TMF Tom9): I don't think it's smart to diversify for its own sake across industries, but each investor should definitely diversify among carefully chosen companies according to her risk tolerance. 

For example, investor and author Philip Fisher advised that no "C" stock -- "C" being roughly the universe of smaller, newer growth stocks -- should comprise more than 5% of your portfolio. Regardless of how many C stocks you might have, you're probably not diversified unless you also have some slower-growing but more solid "A" and "B" stocks in larger percentages. Similarly, David and Tom Gardner advocate an 80%-20% approach for Rule Makers and Rule Breakers, emphasizing that in general, riskier Rule Breaker investments should make up no more than one-fifth of an individual investor's portfolio.

Warren Buffett advises investing as if you had a punch card with 20 lifetime investments. I hear Buffett saying that it's more important to pick individual companies rather than to make sure you have one retail consumer brand company, a drug maker, a software maker, or a semiconductor manufacturer, for example. He's managed to do very well with little diversification by industry. I suspect he knows his risk/reward profile very well.    

Bottom line: Diversify your portfolio by risk, not industry.

Have your views of the "buy and hold" approach to investing changed?
Brian Graney: They have. In fact, I believe in buy and hold even more now than I did a year ago. However, I've seen buy and hold misconstrued more and more in the past year, sometimes grossly so. If you buy a poor quality company or pay too much, holding on to your position for years and years won't necessarily bail you out. But finding great businesses run by smart people, buying them at a discount to their intrinsic values, and holding onto them is still one of the best strategies out there. Price fluctuations steal the headlines in the short-term. But over long stretches of time, fundamental value still carries the day. I don't see how last year's events do anything but reinforce that thinking.

Bill Barker (TMF Max): I was wondering this morning, "Hey, if the Nasdaq were simply to move up 11% per year starting today, how long would it take to get back to 5000?" The answer is nine years, and we're already a year away from when the Nasdaq first hit 5000. So, I think that's one way of framing some of your views on expectations, and buy and hold approaches generally. If the Nasdaq just operates in the next decade in line with the normal historical returns of the U.S. stock market, the 2000-2010 decade will be one of no returns for those that bought in completely at the top (other than dividends, which are pretty paltry in the Nasdaq). There's nothing terribly alarmist about that expectation, either -- Japan's stock market just touched a 16-year low today, so a decade or more with no reward from the market is hardly unprecedented.

Of course for those that are now regularly adding money to the markets via their 401(k) or other retirement vehicles, that would mean that from here on out, should 11% returns from that portion of the market come back, right now would be a perfectly fine and rewarding time to be buying equities. We'll just have to come back in nine years and see.

Any comments on what investors should do now?
Ann Coleman
(TMF AnnC): First, don't compound the mistake of buying high with selling low. You might want to sell a stock that has dropped dramatically, but not just because it dropped. On the other hand, you don't want to hang on forever, hoping against hope that your once-promising tech company will rise from the ashes.

The confusion arises from thinking about selling in the context of a stock's price history. The past matters not. What matters is the price today and the price next year. You can't get back money that has been lost. All you can do is start from where you are now and try to earn the best return you can in the market that is coming.

The economy and the market will recover. So how do you know where a company will be in 2 years, 5 years, 10 years? Not by its price history. Earnings history, well, now, that's another story.

Investing keeps coming back to basic, fundamental analysis, darn it. There just don't seem to be any short cuts. Reading annual reports, checking out the competition, assessing management, that's what you do when you buy a stock, right? (Right?) That's what you do before you sell one, too.

Brian Graney: Keep looking for good companies with good managements that are priced low relative to the cash they will spit out over their lifetimes. The search never ends, regardless of which direction the market indices are headed at the moment.

Rick Aristotle Munarriz (TMF Edible): Odds are you've lost a good deal of money in the market lately. Odds are that no one will be able to string the right words together to make you feel better about your situation. If I can suggest history as a security blanket, knowing that every bear market has eventually brought on new highs, would it comfort you? If I point to valuations, noting how companies are earning far more today than they did back in the winter of 1998, would that color in your pessimism with optimistic pastels? Probably not, so let me just ask you one favor -- keep your head up. We've been through this before. We'll be through it again, no doubt. But we've made it through every single time. Onward.

To see the holdings of any of the writers listed above, just click on their personal profile via the link over their TMF name. The Motley Fool is investors writing for investors.


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