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Rediscovering Stocks At The Wrong Time

With the stock market hovering near record highs last week, I could practically hear the phones ringing in investment advisers’ offices all over the country, as people who fled the market carnage a few years ago wonder whether it is the right time to get back into equities.

No, it is not the right time to get back into stocks. But don't let me stop you simply because your timing is off.

It seems fairly obvious that the ideal time to buy stocks is before their price goes up, not after it has. The reverse is even truer: If you are going to sell stocks, you want to do so before there is a market meltdown, not when the gutters run red with the lava of liquidated portfolios.

Circumstances do not always permit this. If you just sold a business or received a big bonus, you can't go back in time and buy your stocks at the market's recent trough in early 2009. And if you happened to need cash to cover some financial emergency back in ‘09, you might not have been able to help selling your stocks then, even though the timing was extremely unfortunate.

Quite a few years ago, I helped both of my daughters invest their bat mitzvah money in the stock market. My eldest turned 13 in 1999, not long before the market reached its peak during the Internet boom. Her younger sister had her big event in 2002, after the bubble burst and when the market had dropped by about 50 percent from its peak.

Both of them still have their investments. The little sister’s portfolio is significantly larger than her big sister’s thanks to the accidental timing of their reaching spiritual adulthood, though both of them are ahead of where they started. Life dispenses its favors randomly, though I believe things tend to even out in the long run.

But these accidental breaks are not the main reason why most small investors, and far too many big ones, tend to buy and sell at the wrong times. The main reason is that human beings are ruled by emotion at least as much as by logic. You could make a good case that emotion has far greater power.

Stocks - by which I mean the value of stocks as a broad group - almost always increase in value over long periods of time. (The jury is still out on Japan, whose market, like its economy, has been in chronic decline for nearly a quarter-century.) The reason is simple. While individual companies regularly rise and fall, the collective efforts of society build wealth in the economy, and businesses represent a large share of that wealth. As businesses become more valuable, stocks appreciate. It is not complicated, and it is a pretty straightforward principle in which to put our faith.

At times like the market crash of 2008-2009, however, our faith is tested. We watch the value of our assets drop, and drop, and we question whether they will ever recover - or if that recovery will come soon enough to meet our needs. At some point, the temptation to bail out and take one’s losses can become almost overwhelming.

In those bleak days just four years ago, my colleagues and I fielded multiple calls from clients every day. They wanted to sell. We advised them, in the strongest possible terms, not to do so, and in virtually every case we succeeded in persuading them to ride out the storm. We called it “talking them off the ledge,” and in my view, it is the most important work we have ever done as financial advisers.

A temporary market decline, no matter how steep, is just a hypothetical loss on paper. Selling out during a market decline, however, takes a theoretical and temporary loss and makes it both real and permanent. The damage can be devastating, and there is really no way to repair it.

The S&P 500 index reached its record high of about 1,565 in October 2007. Less than 18 months later, it briefly dipped below 700. (Late last week, it was just a hair shy of that 2007 record, while the Dow Jones Industrial Average of 30 large stocks was already in new record territory.)

I vividly remember talking to one client while the S&P 500 index was below 800. Sell now, he instructed me, and buy stocks again when the index gets back above 1,000.

I pointed out that this strategy would absolutely guarantee that he would miss a rebound of at least 25 percent of the market’s then-current value, and probably a bit more. I asked my client why he, or anyone, would want to do that. He had no answer, and he decided to sit tight.

Sitting tight for the long term is the key to successful stock market investing. You have to have enough liquid cash, or at least access to enough liquid cash, to avoid being forced to sell stocks during steep market downturns. You have to know how much of a downturn you are willing to withstand before there is a serious risk that you will lose your courage. My rule: Assume that your stocks can drop by 50 percent overnight and that they can stay at the lower value for years. If you are willing to see your portfolio decline by no more than, say, 25 percent, you should not be more than 50 percent in stocks.

Don’t try to time the market, and most of all, don’t listen to anyone who tells you what the market is going to do in the next six, or 12, or 24 months. That includes me. I don’t know, and neither do they. Since the market tends to go up more than it tends to go down, waiting for stock prices to drop before you buy is more likely to hurt you than to help in the long run.

So should you buy stocks now, when the market it back near record highs? Yes - if you are willing to follow the advice I just offered. The next record high in stocks is not likely to be the last record high for all time. I can’t tell you whether the S&P 500 will reach 2,000 before it drops back to 1,000. I have my suspicion, which is that the good news will come first, but movement either direction is possible. I can tell you with considerable confidence, however, that if the S&P 500 ever gets back down to 1,000, it will someday recover again to today’s levels, or higher.

At today’s prices, this certainly isn’t the ideal time to buy stocks. That happened, most recently, four years ago, when hardly anyone wanted to buy. If you were one of the few back then, congratulations on your fortitude and the success it brought you. If not, don’t worry about the past. Life, as I said, tends to distribute its favors randomly, but the game tends to even out over time. You just need to keep playing.

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2 Responses to "Rediscovering Stocks At The Wrong Time"

  • Larry Anker
    March 14, 2013 - 9:43 pm

    Completely agree, but would have expected commentary about ongoing periodic investment of fixed amount for time weighted average investing.

    • Larry Elkin
      March 15, 2013 - 9:27 am

      You make an excellent point about so-called “dollar cost averaging” investing. Your point is so good, in fact, that it deserves its own commentary. I will try to address this topic next week. Thanks.