The Wall Street Water Torture

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The Wall Street Water Torture
from SmartMoney University

Every day, for 10 full years, you grab the paper to track your portfolio of blue chips, hoping for something to cheer about. But day in and day out, you face the same monotonous drip of endless bad news.

Blue-chip stocks have led the most recent bull market, as companies like General Electric, Wal-Mart and IBM exploded for huge gains. But that wasn't always the case. Back in the 1970s, the bad economic news never seemed to stop coming, and the biggest, best-known stocks suffered through five bear markets from 1966 to 1982.

During the 1970s, people who owned stocks dropped from 50% to 20% of the general U.S. population. Blue-chip prices stayed in the same trading range for more than a decade. Bonds were even worse. Because the '70s featured an odd condition called "stagflation" -- recession coupled with inflation -- interest rates soared despite the economic doldrums. That depressed bond prices, adding to investor woe.

Fortunately, small-company stocks came to the rescue. By 1975, after the worst of the '70s bear markets had ended, profits started to take off for a new breed of young, nimble corporations -- especially those involved in computers. While big companies languished, the stocks of small ones soared almost 131%, adjusted for inflation.

The moral: Just as smart investors never bet the bank on a single stock, they rarely concentrate their holdings in one narrow band of the market. Instead, they spread their assets across a diversified portfolio of big, small and international stocks, not to mention bonds and stable money-market investments.

This strategy, known as asset allocation, takes advantage of the market's one certainty -- that you never really know what's going to perform well and when. While small stocks saved the day in the late 1970s, they've lagged badly at the tail end of this bull market. But if you're properly diversified across the two groups, one will buoy you while the other tries to drag you down.