Investment Advice: Don’t Take A Shovel To Your Stock Portfolio
by Alexander Green, Chief Investment Strategist
September 29, 2008: Issue #862
Suppose you went out to your garage late one night and saw a huge snake coiled up in the corner. If you grabbed a shovel and gave it a few good whacks, you might feel pleased with yourself. But if you turned on the light and found that you’d just cut your garden hose in half, you might feel a little sheepish.
Unfortunately, too many frightened investors are taking a shovel to their stock portfolios right now. Worse still, their investment advisors are goading them on.
I can’t tell you how many times in the past two weeks I’ve heard talking heads in the financial press and on TV tell nervous stock market investors that they need to gauge their risk tolerance and “sell to the sleeping point.” In other words, sell your stocks today so you can sleep better tonight.
This is just about the worst investment advice you can get. If you can’t sleep at night, you may need Lunesta. You don’t need cash investments that yield 2%.
Think rationally, not emotionally, for a minute…
- Cash has done better than stocks over the past year, true.
- That doesn’t mean that cash will do better than stocks in the months or years ahead.
If there is a time to decide that you have too much money in stocks, it’s in a bull market, not a bear market. Yet frightened investors are stampeding out anyway.
Equity Fund Outflows Reaching Record Levels
According to the Investment Company Institute, equity fund outflows are reaching record levels.
In some ways, this is understandable. Many investors are novices. Others are scared out of their wits. Quite frankly, everyone feels a little edgy about the Wall Street meltdown right now, including Fed Chairman Bernanke and Treasury Secretary Paulson, I’m sure.
Every market downturn is scary, precisely because the factors behind each one are different.
People who give professional investment advice should know this:
- Instead of recommending that investors sell now, they should tell them the uncomfortable truth – that is that unless you’re already independently wealthy, you need to own stocks to meet your long-term investment objectives.
- Even if you have a solid long-term investment plan, you’re likely to feel emotional right now. That’s okay. Just don’t react emotionally.
You can stifle your worst instincts by knowing a bit of market history.
Yes, today’s circumstances are unprecedented. But what has been happening to stocks lately is as old as the market itself.
Every Bull Is Followed By A Bear
Every bull market is followed by a bear market. Over the past 100 years, there have been 19 of them in the U.S. The average bull market lasts four and a half years. The last one lasted a little longer, almost exactly five years.
- The average bear market lasts 18 months and results in a market decline of just over 30%. The market peaked 11 months ago. This bear market is probably not over. But we’ve likely endured the worst of it.
- On the other hand, this downturn could be worse than average. It could last longer than usual and take the averages down more than usual.
- But here’s the good news. Every bear market in history was followed by a bull market.
People who panic and “sell to the sleeping point” now are likely to regret their decision when stocks recover. Think about it. You don’t want your investment portfolio to kick the bucket before you do.
“But this could be the big one,” some worry. “This could be The Greater Depression.”
Probably not. During the Depression, we were on the gold standard. There were far fewer steps that the government could take to help stabilize the markets and boost the economy. (And the steps that the government did take in the 30s – raising taxes and passing protectionist legislation – only made things worse.)
However, it never hurts to consider the worst-case scenario.
In October 1929, the stock market crashed. And it wasn’t until July 8, 1932 that the carnage finally came to an end. By then, the market value of the greatest corporations in America had declined an astonishing 89%. Thousands who had bought stock on margin – with borrowed money – went bankrupt.
Investment Advice In The Gone Fishin’ Portfolio
However, in my new book “The Gone Fishin’ Portfolio,” I point out that if you had patiently put a constant dollar amount in stocks each month beginning in August 1929 – the market peak before the great crash of ’29 and the Great Depression that followed – within four years you would have earned a higher return than another investor who put an identical amount in T-bills.
That’s right… after just four years, during the worst period of stock market performance in U.S. history.
Some might argue this was a fluke. So let’s take a look at another extreme scenari Germany and Japan after WWII. Dr. Jeremy Siegel of the Wharton School writes:
“In the 12 years from 1948 to 1960, German stocks rose by over 30% per year in real terms. Indeed, from 1939, when the Germans began the war in Poland, through 1960, the real return on German stocks matched those in the United States and exceeded those in the U.K. Despite the total devastation that the war visited on Germany, the long-run investor made out as well in defeated Germany as in victorious Britain or the United States. The data powerfully attests to the resilience of stocks in the face of seemingly destructive political, social, and economic change.”
The story in Japan was similar. By the end of 1945, stock prices stood at about approximately a third of their level just prior to the Empire’s surrender. Over the next 40 years, the Japanese market returned more than 20 times its American counterpart.
Often, the very best periods of stock market performance come during periods of negative sentiment and high volatility. In fact, the best five-year return in the U.S. stock market began in May 1932 – in the midst of the Great Depression – when stocks returned 367%. The next best five-year period began in July 1982, following one of the worst recessions in the post-war period.
Stocks Consistently Deliver Superior Returns
The investment lesson is this: Over the long haul, stocks have consistently delivered superior returns, throughout expansion, recession, inflation, deflation, and war.
Investing only when the backdrop feels “safe” has not been a good method of achieving high future returns.
Of course, the market can always go lower than you think it will – and for longer than you think it will – before a major uptrend appears. For this reason alone, you should not have money invested in stocks that you will need in less than five years.
But for your serious, long-term money, you need to maintain a significant exposure to high-quality stocks.
Yes, the stock market is unnerving and unpredictable in the near term. But inflation makes your future financial requirements unpredictable, too. That’s why you need to own stocks, to generate the kind of returns that only equities can give.
So relax, think long term, and stick to your plan. Resist the urge to take a shovel to your stock portfolio.
Or to that snake in the corner of your garage…
Good Investing,
Alex
Today’s Investment U Crib Sheet
The Dow Jones Industrial Average is down almost 17% this year, while the S&P and the Nasdaq find themselves down by almost 18%. Those rushing to put their money in “safe” investments are finding cash-like yields refreshing compared to the market’s losses.
Here are some of the current yields on short-term cash investments:
| 6 Month CD | 3.19% |
| 1 Year CD | 3.68% |
| 5 Year CD | 4.14% |
| Money Market | 2.42% |
| Checking | 1.41% |
But with the current inflation rate at 5.37%, these cash investments are robbing investors of purchasing power. However, by sticking with our first Pillar of Wealth – asset allocation – investors can lessen the impact of an equity portfolio.
Long- and short-term investors should be diversified beyond traditional stocks. Our Asset Allocation Model, for example, suggests that you should not have more than 60% of your total portfolio in equities.
You should have 10% in investment-grade bonds, which are up today. You should have 10% in inflation-adjusted Treasuries, which are up today. You should have at least 5% in gold shares, which, again, are up today.
Asset allocation reduces your portfolio’s volatility and protects your capital in difficult times like these. Follow the link to learn more about asset allocation and the Four Pillars of Wealth.
Related Investment U Articles:
- The Ultimate Stock Market Insurance Policy
- Is Your Investment Advisor Capitalizing on Your Fear?
- What To Do With Your Money Today
- The Dividend Stock Recovery: Get Ready for a High-Yield Bonanza
- Why I Don’t Watch CNBC
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Alexander Green is the Chief Investment Strategist of Investment U. A Wall Street veteran, he has more than 20 years of experience as a research analyst, investment advisor, financial writer and portfolio manager.
