The stock market had its worst year in three decades in 2002, with the average U.S. diversified stock fund losing nearly 23 percent. Virtually all stocks were down and only a few fund categories offered any relief.
Gold continued to gleam. The price of gold rose around 20 percent for the year so precious metals funds enjoyed a second straight outstanding year, gaining nearly 64 percent, according to Morningstar Inc., Chicago.
Real money. Real estate funds posted a 4 percent gain, reflecting continued strength in property values. During the three-year bear market, 2000-2001-2002, real estate funds have had annualized gains of 13 percent, second only to precious metals funds (17 percent-plus) among all the fund categories tracked by Morningstar.
Bonds boomed. For the third straight year, bond funds blossomed while stock funds sagged. Except for junk bonds (which fell as defaults rose), all types of bond funds enjoyed solid gains. Long-term government bond funds, for example, returned over 12 percent in 2002, bringing the three-year annualized return to nearly 11 percent.
Ironically, the stock market was holding its own in the first half of 2002, with the Dow Jones Industrial Average near 10,500. Then stocks endured a five-month free-fall that saw the Dow dip below 7,500 before rallying a bit in the fourth quarter.
Why the mid-year plunge? In addition to all the terrorist alerts and corporate scandals, the main reason stock prices fell was poor earnings. Therefore, improved earnings in 2003 could break a three-year losing streak, the first since 1939-40-41, at the end of the Great Depression. With prices off sharply since early 2000, stocks and stock funds may have a reached a point where there’s more upside than downside.
By the same reasoning, bonds and bond funds may have reached a peak, after their three-year run. Bond prices rise when interest rates fall, and rates are now at their lowest levels in decades. If rates head north, bond prices will fall, as was the case in years such as 1994 and 1999.
If it’s time for you to shift some money from bonds to stocks, where should those dollars go? Large-company growth stocks have been beaten up in the last few years so they may be ready for future growth. At the same time, real estate investment trusts (REITs) and REIT funds may have a place in your portfolio because they offer income and portfolio diversification.
No matter which types of funds you choose, look for better-than-average performance during the last three years as well as low expenses, which are very important for long-term investors.
