The cost of missing rallies is huge
CHICAGO: Will Rogers, the great cowboy and humorist from Oklahoma, entertained America during the darkest days of the Great Depression. His investing advice? “The best way to make money is to buy a stock. Then, when it goes up, sell it. If it’s not going to go up, don’t buy it.”
Today’s individual investors still seem to be playing this fool’s game. Despite overwhelming academic evidence to the contrary, most investors think that they can time the market.
But in reality, they are often just following herd instincts or their own irrational impulses and getting trampled. While being out of the market when it is tanking is no sin, not being invested during a rally carries a steep price.
For the last two decades, the S&P 500 index returned an annualized 8.2 percent but the average return of US mutual fund investors was an annualized 4.25 percent, according to the investment research firm Dalbar.
Why the disparity? Investors like to bail to cash and bonds when the market shows volatility, which has been a troublesome gremlin in recent years. Nervous market-timing investors then wait too long to get back into stocks.
Yet the waiting game is costly. Say you had a $ 100,000 portfolio and earned 4.25 percent annually. At the end of 20 years, you would have a lump sum of $ 229,891. Bump the return up to 8.2 percent and your kitty is more than double — $ 483,666. Keep in mind that these are nominal pretax earnings that do not include investment expenses, inflation adjustment or additional contributions. Your final tally could be higher or lower depending on whether you are adding money or investing in low-cost index funds.
What if you are only now re-entering the market from a long hiatus you began in 2008? This is what you have missed just in the last year: The S&P Mid-cap stock index is up about 8.3 percent year-to-date through Feb. 28; the S&P Small-cap index has climbed 7.3 percent and the S&P 500 (large cap) index has risen 6.6 percent.
As for bond indexes, the Barclays US Aggregate Index, a proxy for the US bond market, is down 0.20 percent and the Barclays US Corporate Credit Index is off 0.18 percent.
That means if you had $ 100,000 invested in the US bond index for the last 12 months, you would have lost $200. But if you were in an S&P 500 fund like SPDR S&P 500 Index fund SPY.P, which gained 6.46 percent through Feb. 27, you would have $ 106,460.
Unless you were happy with a loss, or low single-digit yields in government bonds, or insured savings accounts that have not beaten inflation, your caution was overplayed.
Of course, none of these recent returns are guaranteed to continue, but if even a sluggish rebound is gaining momentum, you could be missing some gains.
There are several ways to rationally attack your fear of flying back into the market:
1. Adopt a rational short-term outlook
By short term, I mean year-to-year, not day-to-day. Stop focusing on daily or weekly headlines and look at the big picture. Barring any government-induced slowdown in federal spending — still an unresolved issue — the economy is benefiting from a rising tide and not a receding one. That is bullish for stocks.
2. Ease into the market on a regular basis
If you decide that you can afford to be in stocks and can stomach the risk, commit fixed amounts every month. You can do this either through your regular 401(k) contributions or automatic debits into individual retirement accounts, mutual funds or single stocks you own. Companies that offer dividend-reinvestment plans give you a bonus: Buying new shares without commissions.
3. Stop timing altogether
The all-in or all-out approach is usually a fool’s game. It is nearly impossible to predict market turns. It is perfectly reasonable to combine stocks with bonds — your bond portion should roughly match your age — but constantly shifting between the two is costly. Decide on your asset allocation once a year and review it 12 months later. If you feel that you took too much risk, lower your stock holdings.
There is no harm in being cautious on wild-card scenarios. Remember that there still could be some dust-ups in Washington and drastic spending cutbacks could slow economic growth. And it is tough to predict what is going to happen overseas.
But if you line up your portfolio according to what is likely to occur — given no catastrophes — you will at least avoid buying into a rally late and selling at the wrong time. Sometimes being static is a virtue.
— The author is a Reuters columnist and the opinions expressed are his own.
