Back
in the beginning of 2009, I was talking with a member of the
family. She said that she was bothered by the decline in the
market and was thinking about reallocating her 401(k) money.
The market meltdown last year was a sobering moment for a good
number of investors who were used to a market that only went
up. Many thought that investing was risk free.
Investors pulled $320 billion from mutual funds in 2008--- a
record both in dollars and as a percentage of assets. The
average 401(k) account lost 28% of its value. This was one of
the biggest flights to safety the industry has seen. The move
of what were previously regarded as safe and stable investments
followed a record year of investor inflows in 2007.
I asked
her what she intended to do. She replied, "I think I'll put all
of my allocation into money market funds." I then asked, "When
will you do this?". She replied, "Tomorrow." I then asked,"Why?"
She replied, "Because the market has me nervous."
I said,
"OK, say you get out now. How long will you stay out of your
stock mutual funds? One month? Two months?, three months? And
if and when you go back in, how much of your 401(k) money will
you allocate back to stocks? One hundred percent, 75, 50,
25%.?"
My
family member is like a lot of us. We love the market when it's
going up like crazy. It makes us nervous when it's moving in
the other direction. We want to be fully invested during the
rising market and out of it when prices fall. We want to stay
in the pool when the water is warm but quickly jump out when the
water cools off.
The
problem for my family member and a good number of people is that
when you try to "time the market", you have make three decisions
in a row and they all have to be correct; when to get out, when
to get back in, and when you get back in, how to reallocate your
savings. And the real problem is that very, very, few
people are able to do this over the long term.
Peter
Bernstein, in his book, "Against The Gods: The Remarkable Story
of Risk", states that one of the risks of market timing is being
out of the market when it has a big upward move. "Consider the
period from May 26, 1970, to April 29, 1994. Suppose our market
timer was in cash instead of stocks for only the five best days
in the market out of that period. He might feel pretty good at
having just about doubled his opening investment (before taxes),
until he reckoned how he would have done if he had merely bought
in at the beginning and held on without trying anything tricky.
Buy-and-hold would have tripled his investment. Market
timing is a risky strategy."
Charles D. Ellis, in his book, "Winning The Losers Game", uses
the Standard and Poor (S&P) 500 stock average to illustrate the
problem faced by the market timer. "Almost all of the total
returns on stocks in the 70 long years from 1926 to 1996 were
achieved in the best 60 months---only 7% of the 862 months over
those long years."
"If we
missed those few and fabulous 60 best months, we would have
missed almost all of the total returns accumulated over
two full generations. The lesson is clear. You have to be
there when lightning strikes."
If you can think in terms of "time in
the market" instead of of timing the market, time becomes an
ally rather than an obstacle. The more time your money is in the
market, the more likely you are to achieve the historical
returns of the stock market.
What works? Good old solid asset
allocation. Spreading your assets among a variety of
investments that have different return potentials and risk
levels. A classic study with research by Gary Brinson from 1986
to 1991 found that asset allocation accounts for around 90% of
the returns in investment portfolios; A constant long-term buy
and hold perspective. You can ride out the ups and the downs.
Since 1927 (through December 2008) the
S&P 500 Index has provided compound annual returns of 9.6% even
though we’ve had a Great Depression, numerous wars, bouts of
high inflation, energy independence issues, numerous terrorist
attacks around the globe, excessive exuberance with technology
stocks and now a significant decline in some areas of real
estate and a restructuring of the landscape on Wall Street. The
change has been constant.
According to historical research by
Vanguard, the worst calendar year before now was 1931, when the
S&P index went down 43.1%. If we go down more than 2.5% over the
remainder of this year, 2008 will be the single worst year for
the S&P index since 1926.
The Chart Below shows how the S&P 500 Index has performed
over the past 35 years. Surprisingly enough, the good years
tremendously outweigh the bad ones. This is probably due to
the fact that we are so far off of the historical highs
currently!
Year over Year Stock Market Returns
