When the stock market is headed downward, do you get restless, thinking that maybe you should sell your holdings? Or, when the market is going gangbusters—as it has been doing lately—do you worry about a crash or market correction?
Well, if you invest with the right frame of mind and the right strategy, you don’t have to worry about either extreme. With the right portfolio, you don’t have to do anything different, regardless of what the market’s doing.
And actually, sound research shows that you shouldn’t. The notion of pulling out when the market’s headed down can be extremely hazardous to your wealth. By the time anxiety begins to set in, values have probably already dropped significantly, and fear could tempt you to sell your investments at a loss. Then, completing this sad syndrome, by the time values are headed upward again and you contemplate buying back in, prices are usually much higher. Ultimately, after the dust has settled, you may end up owning many of the same investments you held originally--but unfortunately, after you’ve incurred devastating losses.
Moreover, it’s impossible to predict what the market or any part of it will do at any time because it’s completely random. This is because markets are moved by unexpected, unknowable events, while existing and knowable information is already reflected in market prices. Professional investors have consistently failed to predict the market’s direction. These failures are chronicled in Princeton professor Burton Malkiel’s classic book, “A Random Walk Down Wall Street” (now in its 12th edition)—aptly named because trying to predict the market is truly a random walk; you have no idea where you’re going to end up.
Investing according to predictions of what’s going to happen is known as market timing—a speculative and dangerous practice, overwhelming evidence shows. That’s why this practice is rejected by wise investors and finance experts. Most stock market returns come in bursts, and on precious few days. As it’s impossible to predict which days, it’s extremely important to be in the market when these events occur. Quite simply, you must be in it to win it.
This theme has been expressed by finance experts and legendary investors who say that patience is paramount; you need to have a line in the water when the fish start biting. Echoing this theme of patience, Warren Buffett has said the way to make money in the stock market is to stay invested and sit tight—not by aggressively making trades.
Patient and wise investors have well-diversified global portfolios built to weather inevitable declines and still deliver good returns over the long term. When one part of the market does well, its returns can help balance out the parts in your portfolio that may be down. Sure, a steep market drop can reduce your portfolio’s overall value. But if you invest correctly for the long term, you can still do well by capturing market returns, with strong gains in one part of your portfolio counterbalancing declines in others.
By investing correctly, I mean refusing to gamble by attempting to pick stocks, and instead of using low-cost index funds that track the returns of various indexes, such as the S&P 500. With a well-diversified global portfolio of these funds, you can capture the returns of the market instead of worrying about losses from any single stock. Objective academic evidence has documented that an overwhelming majority of stocks are losers, and trying to pick winners is a fool’s errand.
So, avoid randomly stumbling down the investing avenue without a written financial plan, or any idea where you’re going to end up. Don’t ever give in to the temptation of attempting to time market movements. Instead, patiently stay disciplined and invested for the long term through a well-diversified global portfolio of index funds. An alternative to the speculation of picking stocks, these funds are designed to capture the market’s unpredictable bursts of returns. History shows that those who invest this way are richly rewarded.
Tim Decker is president of ISI Financial Group (isifinancialgroup.com), a wealth management firm in Lancaster, and a fee-only financial planner (he sells no products). His weekly call-in radio show, Financial Freedom, airs Saturdays at 10 a.m. on WHP580 AM.
