As we approach the four year anniversary of the market lows reached on March 6, 2009, recent headlines are touting the DOW’s return to 14,000. While the economy continues to slug along amidst a cloud of uncertainty, investors are starting to wonder if it is finally safe to invest in the markets again. Sadly, these headlines and questions continue to repeat themselves after every market downturn, and the proverbial herd is beginning to follow.
Until recently, investors had been consistently pulling money out of stocks and investing in bonds or cash since 2008. While the broad market has more than doubled since March 2009, net mutual fund flows from US stock funds has been overwhelmingly negative.
This phenomenon underscores the reality that managing your investment behavior is more important than managing your investments. The image to the right, courtesy of Carl Richards at www.behaviorgap.com, demonstrates that we feel good and bad about investing at precisely the wrong times, leading to decisions that are detrimental to our financial well-being.
To reiterate the points made above, only now, after the market has doubled from market lows, are investors beginning to buy stocks again. In virtually any other situation in life, one would be considered crazy for paying twice as much today for something they sold just a few years ago!
Warren Buffett’s two rules of investing are (1) Don’t lose money, and (2) never forget rule #1. Let’s not kid ourselves, Mr. Buffett’s portfolio goes up and down like the rest of ours, but he doesn’t confuse ongoing market fluctuation for losses. Real losses are either caused by overpaying for an investment and/or selling an investment at an inopportune time.
Whenever you are making decisions about investing, always remember that price matters. As Buffett says, “price is what you pay, value is what you get.” The best company in the world can be a poor investment if you overpay for it, while a mediocre company can be a wonderful investment if bought at a great price.
Consider the stock chart for one of our local companies, Target Corporation, at left. The stock performance has been mediocre for an investor that bought it in September 2008 or April 2010. However, it has been a fabulous investment for the investor that bought between October 2008 and July 2009. It is the exact same company. Target operated the same way and sold the exact same stuff. Price matters.
This bodes true regardless of your investment philosophy. It doesn’t matter if you are investing in stocks, bonds, actively managed mutual funds, index funds, ETF’s, real estate, gold, or tulip bulbs. If you overpay, your results will be subpar. If you sell at a bad time, your results will be subpar. Selling when the DOW was hovering around 6,550 in March 2009 produced subpar results, just as holding out until the DOW reaches a “safe” level again is a recipe for subpar results. If you are comfortable investing when the DOW is at 14,000, there is no logical reason you should be less comfortable investing when it is at 13,000. In fact, you should be even MORE comfortable at 13,000. You literally increase your investment risk by waiting until it reaches a higher level.
The financial and academic world often uses the term volatility (and/or standard deviation) interchangeably with risk. It is actually a horrible measure of risk. Volatility of the market was relatively low near the market peak in 2007 and extremely high at the market bottom in 2009. It is mathematically impossible that the risk of loss was lower in 2007 than 2009. Impossible.
Put another way, most people thought it was risky as hell to invest in March 2009. However, the reality is that following a severe market decline, most of the risk has already been realized and sucked out of the market!
Volatility creates trading risk for the short-term investor. But volatility actually creates opportunity for the long-term investor. Depending on your investment strategy, you may view that as an opportunity to rebalance your portfolio by selling off the asset classes that have performed well and reinvesting in the laggards, or you may view it as a buying or selling opportunity for your individual stock positions.
It is critical that you, as an investor, do not shoot yourself in the foot by making decisions that will permanently impair your capital. The evidence outlined above points out that many investors have done exactly that over the past 4 years. We all know intuitively that we are supposed to buy low and sell high, but our biological composition as human beings literally shuts down our intuitive brain at precisely the wrong time. They have created permanent, irreversible financial losses by reacting to fear.
Ultimately, the style of investing (indexing, value investing, tactical asset allocation) you employ moving forward matters far less than allowing yourself to react emotionally to what is happening. Ignore the past, determine your overall strategy, and stay disciplined and dedicated to it. Determining a plan well in advance of future events will greatly decrease the odds of making emotional decisions in the future.