This past spring, the Nasdaq stock exchange took a precipitous 1,700-point drop. The Dow Jones Industrial Average took a similar drop earlier in 2000.

Understandably, this was enough to startle millions of average investors concerned about financing their children's college education or retiring early. Less understandably, it was enough to trigger a cackling contest among the many professional "Chicken Littles" who have made careers of proclaiming the coming crash and warning of the excessive speculation driving the stock market to unsustainable levels.

By late summer, most of these Chicken Littles have ceased their doomsaying. The markets have recovered partially and seem to have stabilized and begun growing. Now, some of the stock market's professional enthusiasts have regained center stage, predicting that the markets will rise to yet unimagined heights.

The old rules of investing still apply

It is entirely understandable that the average investor, even the average professional investor, may be confused. And now that the future of the stock market has become an issue in the presidential campaign, the public is certain to be alternately told that the stock market is "the greatest wealth creation machine in human history" or "a modern-day roulette wheel." Despite the flurry of contradictory claims, a few salient lessons can be drawn from history and economics that may be of some value to the average investor contemplating the fate of his or her 401(k) plan.

First, everyone who invests in the stock market should do so with the full recognition that drops in the market, like those seen earlier this year, or even more severe drops like 1987's "Black Monday," are inevitable. In the short term, markets can make mistakes and overcompensate, which can and does trigger sudden dramatic corrections. In the long term, however, these corrections are of limited importance to the economy as a whole or a reasonably diversified investor.

Second, increased volatility seems to be a reality in today's markets. Drops and increases of 100 points in the Nasdaq have become virtually daily occurrences, often with little apparent cause. The values of well-known new-economy companies like Cisco, America Online and Yahoo often move up and down 5% or 10% in a single day -- again, often without clear reason. Overreactions to mild bad news or even any news at all seems now to be the norm, not the exception.

Many factors likely contribute to this increase in short-term volatility. Momentum traders, the rising use of stock options, computerized "sell" programs, the increasing speed and ease with which investors can sell stocks, and the enormous increase in capital flowing into the market over the last decade may play a role. And absent other policy changes, if the costs of trading continue to decrease and new capital moves into the market, it is possible that this volatility could persist and even increase.

Though it is certainly disconcerting to see these dramatic movements in stock prices, they likely have little impact on investors with an investment timeframe longer than a few months. Investors would be well advised to simply prepare to endure such changes, confident that if they have chosen the companies they invest in well, the peaks and valleys will have little lasting impact on their portfolio.

The new-economy stock market

Probably the most troubling critique leveled by market skeptics is that the current valuation of stocks is simply too high to be sustained. The most frequently used measure is the ratio of the price of a company's stock to the annual earnings of the company, usually known as the P/E ratio.

Historically, a P/E ratio of 30 has been considered very high. It is not unusual, however, for a technology or biotechnology company to have P/E ratios of well more than 100. This ratio has allowed Microsoft and Cisco to grow into the largest companies in the world as measured by Wall Street, eclipsing General Motors and American Express. It also has raised considerable concern among naysayers who point to the trend as evidence that the current stock market is an out-of-control "bubble" certain to pop.

Without a doubt, some companies with high P/Es will fail. But it is unreasonable to compare the P/Es of emerging companies in emerging industries with those of companies in established industries. When a company begins operations, its P/E is almost inevitably high because it likely has low earnings until establishing its products in the market. As today's new-economy companies mature so will the P/Es of the successful ones.

Of course, some companies will not be able to meet those growth rates and will prove to be bad investments and disappear or shrink. The same can be said for companies that today have P/E ratios in the teens. A high P/E ratio does not guarantee that a particular company will fail or succeed. Further, a high average P/E ratio does not mean that the Nasdaq is doomed to collapse.

With all of the above in mind, it is virtually impossible to find a responsible financial adviser who would not suggest that individual investors put the vast bulk of their savings into stocks. If investors can afford to wait 10 to 15 years, most suggest that all or almost all of their assets be invested in stocks. This is because stocks for two centuries have averaged returns 5% per year better than bonds, the other popular investment option.

This does not mean that stocks outperform bonds every year or even every five or 10 years, but on average stocks have been a better investment. When considering options for present investment, the historical record makes a powerful record for stocks. In addition, investors should consider that the risk of stock prices falling is not the only relevant risk; there is also the risk of stocks growing strongly while other investments languish.

No justification for day trading

This in no way should be read as endorsement of frequent buying and selling of stocks -- sometimes known as day trading -- to try to capitalize on short-term movements in the market. A recent study by two University of California professors confirmed that investors who held their stocks longer generally did much better than those who bought and sold regularly. That certainly does not suggest that investors randomly select stocks and hold them come what may, but it does support the wisdom of selecting the companies for investment carefully and sticking with those choices.

If you predict a major earthquake will hit California at the beginning of every year, one year you will be right. This is a truth that many tabloid psychics have built their careers upon, but it is based on geology and probability, not insights from the supernatural. Similarly, it seems that some market pessimists have learned this truth and predict a precipitous drop in the stock market every year. Eventually, they will be right.

That said, equity markets remain the most attractive investment among the major choices. The most likely formula for long-term success is building a diversified portfolio of U.S. and foreign stocks from companies with good products and good business plans, and holding it. Hopefully, investors do not lose sight of that simple point in the face of both the gloom and excessively optimistic rhetoric of the continuing stock-market debate.