The Dow goes up and the Dow goes down. The Dow passes old “highs” and has exasperating downturns. Even when the Dow is going up, there will be pessimists among the media talking heads predicting the next downturn. All in all, no matter where the Dow is, or what direction it’s heading at any given moment, there can be plenty of reason for investment jitters.
The issue in our minds is not whether there will be a correction, but what we should do about it. That’s a simple enough statement, but it represents a sea-change in terms of the discussion which should follow. We don’t believe we should spend any time debating whether or not… We believe we should spend a lot of time talking about what to do when….
Let us go on record as saying here and now that there will be a major correction in the future. We don’t know (and nobody else does either) when it will occur – tomorrow, before this article hits the press or 4 years from now. BUT IT DOESN’T MATTER.
THE FEAR FACTOR
We know corrections can be scary. Investors lose confidence in the economy and in their investments, and this fear builds like a summer storm. Unfortunately, the media’s go-to method of reporting investment performance reinforces the emotions (up and down), and a cycle of fear or exuberance ensues.
The press is quick to point to some index measuring performance in one sector or another and report movements as small as 50 points. As helpful as indexes are, they can also be quite destructive; we tend to focus on them without understanding them. Whether it’s the Dow, the S&P 500, small cap, consumer durables, or one of the many other published indexes, we look at 10%, or gasp 25%, drops as something terrible.
We don’t understand that most stocks on the New York Stock Exchange vary 50% in an average year. That’s right. If we tracked any given stock, focusing on the interim swings, we’d have ulcers by April, pop champagne in July and suffer heart attacks by September.
Investments, whether they are stocks or bonds, are supposed to fluctuate even as their trend heads in one direction or another. So, will there be a “correction” or a “bear market”? Absolutely. But what should we do in anticipation? Nothing!
HOW MONEY IS REALLY LOST
More money has been lost by investors preparing for corrections than has ever been lost in the corrections themselves. The reader might ask then why we’re even writing this article. Because the message of this article is directly contrary to the message delivered by much of the popular press.
Just in these last several quarters (and they are representative of almost all other quarters), I’ve read articles in well-respected magazines preaching polar opposites for the future – descent into the cellar and soaring to the rafters. They always provide the corresponding advice to switch to bonds now or buy their favorite list of stocks now.
Not surprisingly, the biggest mistakes are related to avoiding the drops. Whether the market is actually falling, or someone is just predicting a fall, the recommendations center on how to get out of the way.
THE THREE BIG MISTAKES
The first mistake is known as “lightening up”. Essentially, the investor is advised to lighten up on the stock or the bond portion of the portfolio in anticipation of the downturn in that category.
Investors don’t realize it, but they become market timers through this practice. Over the long haul, market timing has never worked. Although market timing has some track record of avoiding some downturns, it also has a record of avoiding the upturns which are far more important.
One study covering 40 years (480 months) showed that staying fully invested in stocks earned an average annual return of approximately 12%. But, missing just 20 of the best months decreased the average return to 6%. That means that if your timing was off just 4%, you would have lost half or so of your potential return.
The second mistake is hedging the portfolio. Anticipating a drop, the investor is advised to use futures or options – things which supposedly make a profit when the market drops – insurance if you will.
Unfortunately, if the market doesn’t drop, then the investor has to “renew” the insurance. Pretty soon, investors don’t know whether they’re praying for a downturn to justify the insurance or for an upturn. Even professional hedge fund managers haven’t mastered the art.
The third mistake is a cousin of the first. In fact, they’re probably fraternal twins. Using “switching services” has been popular from time to time. Switching services charge fees to tell investors when to switch between cash, bonds and stocks.
Like market timers, they ultimately lose a lot, but unlike market timing, they charge horrendous amounts for their advice – sometimes upwards of 3 times what mutual fund managers are charging.
THE LONG-TERM VIEW
Whatever the direction or the amount of the next market move, remember that the underlying operative investment principals here are positive!
Whatever happens in the next 6 days, 6 months or 6 years, the ultimate direction of our country’s economy and our world’s is forward – and dramatically so. This has been true for several hundred years and shows now realistic signs of abating.
It was not simple hyperbole when President Lincoln said that our country offered “the last best hope of earth”. As further proof, I offer the following:
• The microprocessor has started an industrial revolution which, as George Gilder has observed, will eclipse the last industrial revolution several fold. We see it every day in new tech products or in new “artificial intelligence” capabilities built into existing products.
• As Sir John Templeton pointed out, it took 1,000 years for our standard of living to double, but it will probably double for the world as a whole in just the next 20 years.
The investment markets will ultimately reflect our country’s, and ultimately the rest of the world’s, not-so-steady-but-nonetheless-forward progress. Will there be some interruptions? Of course, but investing for the long term will inevitably allow you to reap the rewards which are coming.
THE PERFECT PORTFOLIO
Nothing in any of the above implies that investors should solely be in stocks – or solely in bonds for that matter, or solely in anything. The “perfect” portfolio is the portfolio designed with the investor’s time frame solidly in mind, structured among stocks, bonds, and cash accordingly and, most importantly, not disturbed in the short term by worry or exhortation about the next pending calamity.
The only true calamity is making long-term moves based on short-term events. So spend the time needed to really develop an investment plan that’s right for you – reflecting your life goals and your willingness to tolerate volatility – and then stick to that plan through all the ups and downs, and most importantly through all the wild predictions in either direction.