Ten years ago this month, the stock market suffered through its steepest plunge of the modern era, with the Dow Jones industrial average tumbling 508 points in a single day. Investors and brokers who sat tight through the debacle were well-rewarded, of course.
But if you had to pick a single group of winners in the wake of the 1987 crash, it would be hard to ignore mutual fund companies. Trends in the mutual fund business are instructive of how the entire investing landscape has changed after the crash and the disastrous financial services market that followed the drop.
Assets have grown fivefold since late 1987, with a huge expansion in the number of funds and investment options. The rise of 401(k) plans has been a huge factor fueling asset growth, as have low inflation and moderate interest rates, and the fact that everyone seems to be making money: For example, 98% of growth funds as well as growth-and-income funds with 10-year records, have at least doubled in value since the crash, according to researcher Lipper Analytical Services in Summit, N.J.
The same can't be said of individual stocks, some of which fell during the crash and never really got back up. "Most people will tell you they've never had a mutual fund drop to zero," says Troy Shaver, executive vice president at State Street Research in Boston.
Nowadays, you also hear a mantra called "asset allocation," a strategy uniquely suited for funds. This idea of spreading dollars among dissimilar investments really blossomed after the crash of 1987 as people noticed that cash and bonds held up.
The allocation angle has been further refined in recent years, as terms like "target weightings," "style boxes" and "rebalancing" entered the mainstream investment lexicon. Fund companies responded with more specialized products designed to give people exposure to investment niches like emerging markets stocks and REITs.
"The idea is to let investors mix funds to obtain varying degrees of risk," says Geoff Bobroff of Bobroff Consulting in East Greenwich, R.I., including sector risk similar to what they used to get with individual stocks.
Brokers have hastened the allocation trend by switching from being stock jockeys to financial consultants, helping clients determine their risk/reward profile and stay on course. Mutual funds have become the basic building blocks for their practices. "Brokers don't have time to do asset allocation and be responsible for individual stock and bond selection," says Joseph Duran of FundMinders, a firm in Sherman Oaks, Calif., that constructs portfolios of funds for brokerage clients.
But the rise of mutual funds has not come without its problems. "To an extent, we have subdivided too far," says Bobroff. In his view, the grouping of funds into narrowly defined investment categories and ranking them against their peers has become excessive, and created a climate where investors chase past performance and star ratings.
"It was nicer [years ago] when you bought a fund simply because you wanted its value to go up."
A. Michael Lipper of Lipper Analytical Services worries about investor greed. "Every time there's a market decline these days, people buy," he says. Sooner or later, stock prices won't recover so quickly and investors may become disillusioned. Even with lip service paid to long-term investing, a lot of people continue to chase short-term fund performance numbers, which are more widely circulated than ever before.