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Monday, 6 August 2012

Two Reasons to Stay Invested (And One Reason You Should Be - If You're Not)

Two Reasons to Stay Invested (And One Reason You Should Be - If You're Not)Anyone who knows me or works with me knows that I do not believe it is possible to time the market - that is, to decide the right time to get in or get out of the market with any degree of success. We have access to a great deal of information these days, much of it coming from the consumer targeted financial media that each and every day endeavors to point out all the bad news that's out there and suggestions for what we should do about it. It is crisis based and almost never gives us real information upon which to build a long term investment strategy.

With so much negative news about the world's economy, it's easy to forget the basic investing truths that have withstood the test of time. One of those is that staying invested in a diversified portfolio of predominately quality equities (stocks) over time has proven to be a very reasonable strategy to achieve real growth.

Reason to Stay Invested #1 - the High Cost of Market Timing:

To state it more accurately, perhaps I should say the high cost of not timing the market correctly. You cannot invest directly in the S & P 500 Index as it is merely an index comprised of an unmanaged group of securities, but it is considered generally to be representative of U.S. Stocks, specifically, Large Cap U.S. Stocks. The total return of the S & P 500 for the 20 year period ending 12/31/2011 was 7.8% per year. Remove the 10 best days of the year and that average return drops to 4.1% per year. Remove the 30 best days of the year and the average return drops to -.4% per year, in other words no return at all.1

Now I suppose one could argue that had they missed the 10 worst days, the return would have been better than the average. But this misses the point, which is, how can anyone know in advance which will be the good days or which will be the bad? Each correct guess to get out requires another correct guess to get back in. And the process must be repeated correctly each time. Since no one can do this, the next best strategy is to stay invested... which allows you the best opportunity to experience equities' historically superior long term returns.

Reason to Stay Invested #2 - The High Cost of Market Timing II: (in case you weren't convinced)

Let's stick with our theme using the S & P 500 Index as a proxy for U.S. Stocks. We already know this produced a 7.8% per year average annual return for the 20 year time period ending 12/31/2011. What we also know is that the average equity investor's return for the same time period was a mere 3.5%, or less than half of the return achieved by an unmanaged index.2 DALBAR (the group that develops this study each year) attributes this difference to investor behavior, or stated more accurately, bad investor behavior. In other words, the average investor won't stay invested. They will instead panic and sell at the bottom, and then re-commit when the market has already recovered much of any decline. They are forever trying to time market exits and entries - and doing it badly. The better plan is to hang in there, rebalance if warranted and be there for 100% of the recovery when it occurs.

One reason you should be invested now... assuming you're not...

According to the Investment Company Institute, we are in the middle of the sixth straight year of net liquidation from equity based investments. In other words, if the trend continues, by the end of this year, more money will have left equity or stock based investments than has come in - for the sixth straight year - in spite of the fact that U.S. Corporations are actually in pretty good financial health as group. This typifies the frustration of the average investor, I think, and may be a bottoming out of confidence. Another view on this might be that it's an opportunity. Things will get better eventually as history has demonstrated and often when we are able to look back on these time periods, things started to look better just when it seemed they couldn't look worse. We just didn't know it at the time. In terms of this being an investment opportunity, you can be a little early and be patient, or you can be too late. I know which one I want to be. Now, I don't want this to sound like a timing recommendation (and I don't think it really is) but, if you are not currently invested, I think this could prove to be a great long term buying signal.

One more thing to consider...

A number of years ago, 1979 to be exact, there was a cover story in Business Week called "The Death of Equities"3. It went into great detail about how stocks were a bad investment in "these times" and outlined a number of reasons why they probably wouldn't be a good investment anymore. Things had changed - "this time was different."

I thought of that article while reading another one last May in USA Today, the title of which was "Invest in Stocks? Forget About It."4 This is just one of a number of similarly themed articles that seem to be surfacing more recently, additional evidence in my opinion of a bottoming out of confidence and the popular media's desire to take advantage of it. Fear sells more papers than optimism.

That article in 1979 couldn't have been more wrong - as we know now - and I am confident that this latest example will eventually suffer the same fate. To me, it just makes the opportunities look better.
2011 Andex Chart, Columbia Management Investment Advisors, LLC, U.S. Large Stock Annualized Total Returns, 1992-2011.
DALBAR uses data from the Investment Company Institute, Standard and Poors and Barclays Capital index products to compare mutual fund investor bdhavior with an appropriated set of benchmarks. These behaviors are then used to simulate the "average investor."
Business Week, August 13, 1979
USA Today, 5/8/2012

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