Blogs > Your Money

Dave Patterson and Erin Preston, a father-daughter team of Certified Financial Planner® licensees, provide thoughts and suggestions on a broad collection of personal finance topics.  Information provided in this BLOG is intended to be of a general nature and may not be appropriate for all situations.  Readers should consult with their own financial advisors before relying on any information contained herein.

Thursday, August 13, 2009

Be Careful of the Latest Hot Investments – You May Get Burned!

It’s hard to imagine that there’s anyone who didn’t have their portfolio take a big hit the last couple of years. Now that the market seems to be recovering, everyone is starting to get more comfortable with investing again and trying to figure out how to invest their cash.

With big losses to make up, it’s tempting to turn to the latest hot assets. Three that you hear a lot about at cocktail parties and over the backyard fence are gold, emerging markets and commodities. Gold and commodities are hot because a lot of investors fear that we are headed for high inflation due to the extraordinary high levels of government spending, both planned and committed. Emerging markets are hot because investors are betting that the higher growth in emerging markets (compared to the U.S.) will lead to higher earnings.

A recent article by Jason Zwieg, in the Wall Street Journal (“Under the Emerging Curtain”, July 25th, 2009) discussed the recent frenzy for emerging market funds and how investors were likely to be disappointed. As of the end of July, the MCSI Emerging Markets index was up over 45% for the year, versus 9% for U.S stock funds. Jason noted that investors had poured over $10.6 billion into emerging market mutual funds so far this year. That was, he said, more than 34 times the total they added to U.S. stock funds.

The reason for this difference, Jason said, was because the emerging market economies were growing significantly more then the U.S. economy. “Unfortunately”, Mr. Zwieg noted, “high economic growth doesn’t ensure high stock returns.” He went on to note that a study by Elroy Dimson of London Business School and a leading authority on financial markets had found in a study of 53 countries over many decades, that countries of high economic growth have lower stock returns than countries of lower economic growth. In other words Mr. Zwieg said: “ Over the long run, stocks in the world’s hottest economies have performed half as well as those in the coldest.”

So what causes this apparent phenomenon? It’s caused by investors’ expectations that they will earn more by investing in these hot economies. Unfortunately everyone else does too and this results in the emerging market stocks being over-priced. Then when things cool off, everyone gets hit hard.

Unless you are a very early investor and are smart enough to get out early, you will likely pay a steep price to buy into any hot asset class. And, if you’re like most investors, you hesitate to sell your winners and will be likely to hold on too long. The result – a poor return or perhaps even a big loss when the bubble bursts.

For the average investor, you’ll be better off with a diversified portfolio of lower risk asset classes that you periodically rebalance in a disciplined manner. Avoid chasing the latest “hot” investments and you’ll likely do better in the long run.


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