How Much Can I Pay You To Do Nothing?
I can still remember my first market crash, and boy was it a doozy. October, 1987. I had been investing for a few years, learning the ropes, and as I headed back to my junior year in college that fall, there were rumblings in the market place. Then, out of nowhere, wham! The entire year’s worth of gains wiped out in a few hours. In the following three plus decades, there have been countless corrections (10%+ declines), bear markets (20%+ drops) and even a Great Recession the likes of which the esteemed Warren Buffett had never even witnessed during his nearly 7 decades of investing.
Yet through it all, had you a prudent plan in place of cash covering near term needs and stocks invested for 3-5 years or more, the best course of action at the time would have been to do nothing. Or better yet, plow as much money into the market during the decline as possible, either through dividend reinvestments, retirement account contributions or otherwise.
We now have another such event firmly in the rearview mirror. The events of October through December 2018 are close enough so the memories are fresh, yet distant enough to give us some emotional perspective. While no one could have predicted the actual bear market period (the point at which stocks had officially declined more than 20%) would be so brief – a matter of hours for actual 20% declines, and a mere couple of months until full recovery - the reality is that most market declines are short lived. Like with any pain-inducing events, however they may feel like forever at the time, but chronologically they are merely blips.
I have two young-ish kids who regularly fight. It starts with some rumblings, a threat or two, then out of nowhere limbs are flying. Next thing you know someone is trapped in a big bear hug on the ground screaming “…let me go!!!” I used to react to every little skirmish, even the early stages, but I learned over time that often no action is the best action. Whatever caused the initial reactions quickly comes and goes, and everything returns to normal in short order. Often my reactions only made matters worse. Sounds familiar…
The Stock Market Is Rigged
Long before our President declared anything that did not favor him “rigged”, many people have referred to the stock market as a form of gambling. Indeed, many things in life are a gamble if you don’t know what you are doing. Put a 15-year-old with no experience behind the wheel of a car and you are taking a big gamble. For an experienced driver, the risks are almost nil to drive down along a busy highway.
A comparison can be made between gambling and stock investing, but it is a favorable one. If you enter a casino in Vegas, any financial outlay you make has by definition odds working against you for a favorable outcome. Using roulette as an example, the house has a slight edge - under 1%. They understand that on any given spin of the wheel, they may win or lose, even big, but they know from basic math that when you spin that wheel hundreds or thousands of times, then their small edge will lead to positive returns for the house and losses for the poor suckers downing free watered down margaritas.
To extend the analogy, the stock market as defined by the S&P 500 is like a big roulette wheel, only you are the house, and your edge is something like 7% or 8% annualized over time (the average annualized return of stocks over very long periods). Yes, on any given ‘spin’ (day of trading), the market may be up or down, even after a couple hundred spins (i.e. a year) returns can be negative, but if you match your stock investments to the appropriate time horizon, e.g. 5 years or more, then you have 1000+ ‘spins’ to get those positive returns (miss only 10 good spins in a year and your returns can be cut in half or more). And to add to your favorable odds, if you own dividend paying stocks, you get paid regularly for the chance to spin over and over and over, day after day, week after week, month after month, for years, with the confidence that if you don’t exit the game when the table is working against you, then as the house, odds will work in your favor.
It always amazes me how such a basic concept can be lost on investors who can’t see the forest for the trees. Imagine being the new owner of a casino, the roulette tables having made a fortune for the hotel for years, and in your first week a bad streak hits the roulette floor. “Let’s close shop (i.e. getting out of the market) until things settle down” you tell the managers. Similarly, for many so-called investors, even with long-term odds of positive returns vastly in their favor, one small losing streak as we witnessed last fall, and all bets are off. Time to take the….losings…off the table. Then of course the market rebounds, investors feel comfortable investing again (was it buy high and sell low or buy low and sell high?!?), and inferior long-term returns ensue for those focused on timing the market rather than time in the market.
The natural reaction to a market decline is to do something. To feel in control. But if you planned well and the funds are intended for some financial event far into the future – retirement, etc., then doing nothing is almost always the best course of action. A disciplined Financial Advisor can help you define and more importantly stick to a well thought out plan through all inevitable market conditions, and keep you from engaging in a bear fight you’ll never win.