As I mentioned before, I am currently reading an investment book called A Random Walk Down Wall Street. There could not be a more relevant time to be reading it, as you can see the principles that he lays out operating in action in the market on a daily basis.
Contrary to what sterile economic theory has taught for decades, one thing that has been consistently borne out by empirical data over the years is that investors do not behave in a completely rational manner. Alan Greenspan called the internet boom of the late 90s a product of “irrational exuberance” but that principle also works in reverse as well. When the market goes up, investors have a tendency to believe that happy days are here to stay, and when it goes down there is a tendency to believe that it will never go up again. Both are obviously wrong, and both trains of thought will hurt you if you fall prey to them.
Let me ask a question. Taking crowds out of the equation, would you rather do your Christmas shopping on Black Friday when everything’s on sale or a week before Christmas on ebay where you may end up paying two to three times the retail price to get your kid the last whatever-the-hell that season’s must have trinket is? Most people would opt for the former, because all things being equal people prefer to pay less for something when they can. Seems to make sense, right? Well, shockingly enough the market tends to work in almost the exact opposite manner. Then again, considering the amount of business done on ebay at exorbitant prices in the days leading up to Christmas, perhaps it’s not so surprising after all.
Take a look at the following graph (apologies that it's slightly askew; I had to copy and scan it from the book), and please take a few minutes to fully absorb what it is saying, because it tells a fascinating story.
It is a measure of cash flow into and out of equity funds (i.e. mutual funds) in relation to the S&P 500 (which, even better than the Dow, is a good proxy of the market as a whole). What it shows is that when the S&P is riding high, investors are lining up to get onboard. They can’t wait to throw their money into the market. Then when it takes a dive, investors make a mad dash for the exits like rats on a sinking ship. The thing is, the ship is not sinking. Markets are cyclical and thus peaks and troughs are as unavoidable as they are unpredicatable. I am certainly not advocating that you try and jump ship when the market is high and get in when it’s low. I am saying that the best course of action is to not try to time the market at all. You have a far greater chance of hurting yourself rather than helping, as evidenced by this:
“Professor H. Negat Seybun of the University of Michigan found that 95 percent of the significant market gains over the thirty-year period from the mid-1960s to the mid-1990s came on 90 of the roughly 7,500 trading days.”
Now, I’m sure that there are at least somewhat similar numbers for market downturns, but keep in mind that over the last century the market has consistently trended up (from a Dow of virtually nothing in the 1930s to over 8000 today). The question then becomes, do you really want to play the market and risk missing out on the ~1.5% of the days where most of the gains occur?
So, to be clear on what I’m advocating, if you’re already invested in the market: do nothing! Resist the urge to jump ship along with the other rats. If you currently have nothing in the market this is one of the best opportunities to get involved, and I would strongly advise doing so by buying a broad-based index fund (like the S&P 500) rather than try to pick out your own portfolio.
Some caveats, though (and aren’t there always?). First, I am advising holding on to your investments absent the specific knowledge that any one particular company in your portfolio is a dog (AIG, for example, although I’m actually not ready to throw in the towel on them yet). Second, if you are contemplating retirement soon you may very well want to consider moving into a more stable investment. The market will recover, but your financial needs may not allow you to wait long enough to reap all the benefits when it does. Lastly, when I say that “now is the time to get in” I am not talking about maxing out your credit card on cash advances. I am talking about if you happen to have money (in savings, CDs, etc.) that you don’t plan to touch in the near future and can live without. Neither I or anyone else can tell you exactly when the market is going to turn around, and there’s certainly no guarantee that it won’t drop another 1000 points or more. But what I am confident about is that over the long term it will recover. If I had to put numbers to it, I’d say assuming you invested today in the S&P 500 (currently trading at 899) I am 60% confident that you will see a significant positive return (i.e. greater than that which you’d find in a “safe” investment like an FDIC-insured savings account) in a year, 75% certain you will see one in 2, and 99% (because nothing is absolute) that you will see one in 5.
Now, if you’d like to press me to recommend a specific company, I would have to go with GE (currently trading at $21.50/share). There are a lot of reasons I like them, but probably the biggest is the fact that Warren Buffett just invested $3 billion in them and by and large the man only invests in solid companies. They also are a bargain right now because GE credit is struggling (along with every other lender) but I believe that will eventually recover, and there is still a large amount of demand for their turbines and jet engines. But, again, I am talking about long-term investing here. One of Warren Buffett’s most famous statements is that “the correct holding period of a stock is forever.”
Of course, I would be remiss if I didn’t also point out another piece of advice I gleaned from A Random Walk Down Wall Street:
Stay Cool to Hot Tips
Tips come at you from all fronts – friends, relatives, the telephone, even the internet. Don’t go there. Steer clear of any hot tips. They are overwhelmingly likely to be the poorest investments of your life. And remember: Never buy anything from someone who is out of breath.
So I guess what I’m saying is that if you listen to what I’m saying, you definitely shouldn’t be listening to what I’m saying.
How’s that for ambivalence?
“Professor H. Negat Seybun of the University of Michigan found that 95 percent of the significant market gains over the thirty-year period from the mid-1960s to the mid-1990s came on 90 of the roughly 7,500 trading days.”
Now, I’m sure that there are at least somewhat similar numbers for market downturns, but keep in mind that over the last century the market has consistently trended up (from a Dow of virtually nothing in the 1930s to over 8000 today). The question then becomes, do you really want to play the market and risk missing out on the ~1.5% of the days where most of the gains occur?
So, to be clear on what I’m advocating, if you’re already invested in the market: do nothing! Resist the urge to jump ship along with the other rats. If you currently have nothing in the market this is one of the best opportunities to get involved, and I would strongly advise doing so by buying a broad-based index fund (like the S&P 500) rather than try to pick out your own portfolio.
Some caveats, though (and aren’t there always?). First, I am advising holding on to your investments absent the specific knowledge that any one particular company in your portfolio is a dog (AIG, for example, although I’m actually not ready to throw in the towel on them yet). Second, if you are contemplating retirement soon you may very well want to consider moving into a more stable investment. The market will recover, but your financial needs may not allow you to wait long enough to reap all the benefits when it does. Lastly, when I say that “now is the time to get in” I am not talking about maxing out your credit card on cash advances. I am talking about if you happen to have money (in savings, CDs, etc.) that you don’t plan to touch in the near future and can live without. Neither I or anyone else can tell you exactly when the market is going to turn around, and there’s certainly no guarantee that it won’t drop another 1000 points or more. But what I am confident about is that over the long term it will recover. If I had to put numbers to it, I’d say assuming you invested today in the S&P 500 (currently trading at 899) I am 60% confident that you will see a significant positive return (i.e. greater than that which you’d find in a “safe” investment like an FDIC-insured savings account) in a year, 75% certain you will see one in 2, and 99% (because nothing is absolute) that you will see one in 5.
Now, if you’d like to press me to recommend a specific company, I would have to go with GE (currently trading at $21.50/share). There are a lot of reasons I like them, but probably the biggest is the fact that Warren Buffett just invested $3 billion in them and by and large the man only invests in solid companies. They also are a bargain right now because GE credit is struggling (along with every other lender) but I believe that will eventually recover, and there is still a large amount of demand for their turbines and jet engines. But, again, I am talking about long-term investing here. One of Warren Buffett’s most famous statements is that “the correct holding period of a stock is forever.”
Of course, I would be remiss if I didn’t also point out another piece of advice I gleaned from A Random Walk Down Wall Street:
Stay Cool to Hot Tips
Tips come at you from all fronts – friends, relatives, the telephone, even the internet. Don’t go there. Steer clear of any hot tips. They are overwhelmingly likely to be the poorest investments of your life. And remember: Never buy anything from someone who is out of breath.
So I guess what I’m saying is that if you listen to what I’m saying, you definitely shouldn’t be listening to what I’m saying.
How’s that for ambivalence?
5 comments:
Whew, I am so glad you explained that graph. First you were all, "Study this closely and think about its implications before you come back," so I did... but I had no idea what the cash flow thing meant so I was at a loss. But yay, you explained.
Thanks for the tips. Follow-up question 1: Given the market situation, is now a more opportune or less opportune time for proprietors to start or expand a small business?
Follow-up question 2: Would you recommend investing in real estate (including multi-unit buildings and empty lots)?
FUQ 3: Would you recommend investing in yourself (i.e. education)?
John:
I totally agree with you on the current climate. More than just GE are on clearance sale right now. This week will probably be a roller coaster with some major earnings reports coming out, but if you're buying while the market is below 9,000, shiat, even 10,000, you're going to make money, and sooner rather than later(maybe). And I would like to respond to Becky's question. Real estate is a great investment at this time, if you have cash to pay for it. If you plan on financing your investment, especially a multi-unit investment property, you'll be unpleasantly surprised by the new and ever-tightening lending standards. Some lenders want a very significant down payment on IP's (I've heard of some wanting 30-50%)and have new fees such as the "adverse market" fee and other crap like that to offset recent losses. So yes, if you're sitting on a couple mill in cold hard, buy up as much RE as you can-there are deals to be had, especially in areas like GE that have a massive inventory in a nice area and little demand for it.
Becky, pretty much the answer to all 3 questions is yes - if you have the cash or if you can get the credit. The 2nd part is a lot trickier right now (although as far as education goes I'm still reasonably sure you can get student loans).
Dan is closer to the real estate market than I am but I contacted Ken (Dan's friend who was our loan officer) and he said you can still get an FHA loan which only requires 3.5% down. However, I think in your case you would want to put down as much as you possibly can in order to lower your monthly payment and to partially or completely eliminate PMI.
I feel about real estate pretty much the way I do about the stock market. Prices are low, so now's the time to get in. Sure, they might go lower but we will only know when they've hit the low point in hindsight. Thus, if you buy in the next 6 months - a year you can still be reasonably certain that 5 years from now you will have equity, regardless of whether or not prices dip lower between now and then.
John:
Was Ken giving you that rate on a multi-unit investment property? I think that program is only for owner-occupied residences. See what he as for multi-unit investments (5+units) and I guarantee it's not 3%.
Well, I don't think you can even do an FHA loan as an investment property but I was assuming that Becky was asking about a place for her to live in. Yes, pure speculative real estate in this climate is much more difficult but I can't believe they'd want more than 20% down.
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