A Hedgehog Commentary

Some Lessons Learned

11/08/97 - They say that you only learn through failure. If that's true, I guess a lot of us have received quite an education on the market the past few weeks. I thought I'd go over some of the things I've learned (actually I already knew most of this but just wasn't applying it).

1. Maintain a cash reserve. One of the problems with being fully invested is that when a market drop occurs, not only do you take a big pounding, you won't have the resources to take advantage of some good deals. While I normally do maintain a reserve, I bit too soon on some modest deals and was fully invested when the real drop occurred. From now on I promise to keep some cash until the market is clearly bottoming no matter how tempted I am by what's out there.

2. There really is some logic behind the idea of diversification. I've never quite bought into the idea of diversification as financial planners have put it, that you should have so much money in a broad range of stocks, so much in bonds, etc. If you have a timeline of many years, it seems to me you are almost certainly better off with all your money in stocks, with maybe a short position or two if the market seems to be getting overvalued. However, I had gotten too loaded down with tech stocks. Obviously, these stocks have been the best performers and had done well for me in the past, but there were other sectors that were clearly doing just as well with good values that I should have been in as well. The drilling services sector comes to mind in particular.

3. Don't panic. I didn't do this, and it sounds like most small investors didn't. The pros though reeked of fear. Frankly, it serves them right if they got clobbered. If the small investors hadn't held steady, who knows how far this market would have dropped. Option writers in particular got pounded as they tried to minimize their losses by selling shares, which drove the market down further, and actually increased their losses. Yesterday's WSJ actually discusses on option trader who was completely wiped out.

4. Be patient. It certainly is frustrating to see your portfolio tank. It would be easy to obsess over it and wonder what you should do next. One answer may be to just let it sit and forget about it for a few days. That's what I did. Soon, my losses had been cut in half and I hadn't spent all my time worrying. If the stocks you own are fundamentally sound, they will almost certainly recover sooner or later.

5. Resist temptation. I'm often tempted to want to day trade. Right now, it looks to be little better than gambling as prices for many stocks seem to recover only to drop again. If you buy a stock that seems a good value, be prepared to hold it. There's no guarantee that the market won't drop again.

Well, this is some of what I learned. Nothing really earth shattering, but things to keep in mind when this happens again. And it almost inevitably will.