What not to buy in a bear market

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NEW YORK (Money Magazine) -- "Look at how well these investments performed during the 2000-02 bear market!" This is the line I've been hearing from mutual fund companies and other investment providers trying to sell me on the superiority of their products (and get me to put clients into them).

That means I'm being pitched the standouts of the past bear market, including small-cap and value funds, real estate and metals and mining.

From the beginning of 2000 to the end of 2002 - when U.S. stock funds lost 12% a year on average - small-cap funds dropped by 6.5% a year, and value funds fell by just 2% a year, according to Morningstar. Real estate and precious-metals funds - two groups that often do well when the stock market slumps - delivered double-digit annual gains.

Many financial planners I've talked to are buying this pitch hook, line and sinker and are investing clients in these funds. It's why your adviser may be showing you pretty graphs nowadays that illustrate how well his current recommendation stood up to the bear last time.

Weak Theory: This seems like a logical approach, until you realize that it is based solely on one bear market. It's possible that what happened once could happen again - but it's far from probable. In fact, over the past year, while U.S. stock funds are down nearly 13%, small-cap stock funds are down 14%, value funds 19%. So far, the logic is failing miserably.

If your adviser is moving you into anything that did well during the past bear market, not only is she engaging in straw-grasping but she also doesn't understand the market. By hoping that what did well last time will do well again, she's engaging in a form of performance-chasing.

Long View: A much better strategy is to build a portfolio that holds many different asset classes and stick with it. Once you have a proper asset allocation, all that's needed is simple rebalancing. This is the opposite of performance-chasing, since it means that today you probably have to sell some of your safe bonds to buy risky stocks.

Let me clue you in to something: We advisers have no idea whether the bear market is nearing the end or still has a long way to go. So don't let any adviser shift you away from a long-term strategy under the guise that he knows what's going to do well next year. A quote I often use by Warren Buffett, "Be fearful when others are greedy and greedy when others are fearful," particularly resonates now.

The Mole is a certified financial planner and certified public accountant who - in the interest of fairness - thinks you should know what goes on behind the scenes in financial planning. Want to make contact? E-mail themole@moneymail.com.