It is popular theory to push the Passive Investment strategy upon all savers, the common logic for such a strategy is that Active Investments are inefficient because they cost more in terms of tax and trading fees. There is a lot of truth to this, and there are a massive number of mutual funds that are actively managed, coming with large management fees that destroy any potential earnings.
However, it would be naive of us as investors to ignore market risk when following an investment strategy. We can keep the tool of our asset allocation vehicles low cost, such as deploying a Vanguard or other low cost broad sector or index fund but where we decide to allocated, within stocks, bonds and cash I feel should change based upon market factors.
The common logic is buy low, sell high. But most investors fail to follow this rule due to a behavioral quirk – the fear of being wrong and mocked by our peer as they grow richer. If you look at any of the investors who held Hedgefunds betting against the housing market prior to the CDO bust they will all tell you that they were losing investors since they lost confidence in the firm to properly gauge the market. Many of the people who rightly thought that people were losing their minds betting on Sub Prime mortgages knew so early, and missed out a bit on the heat of these funds changing hands. However, a short term loss on this profit taking was hardly important when their bets finally paid off, and they earned Billions of dollars as the markets crashed.
So, when is the right time to bet against the market? Clearly when it is high. The higher the Dow ticks the more likely it is to finally explode and again we face a crash, the cycles of boom and bust have been with us for years, it is a constant case of correction, and recorrection. Within this ebb and flow you find most investors on really start to sell once they see their investments at risk, IE when they are shedding value. But the secret to investing is to buy low, sell high….
There is no way possible to time the market properly, in that it is impossible to say what it will do tomorrow. However, the market has risen over 110% in the past 4 years…
Lessons from the past
Past performance does not guarantee future success, we cannot look backwards and predict the future, but failing to look back and recognize similar events unfolding would be a dangerously narrow approach to predicting trends in the future. Let’s look at the 5 largest gains in stock market history, just like this one they all came after a large, seemingly catastrophic crash.
- 1935-37 132% Gain
- 1942-1946 146% Gain
- 1949-54 266% Gain
- 1982-87 226% Gain
- 1987-2000 562% Gain
What all of these have in common is that before, and after, each one was a loss. Even in 1987 there was a single day, Black Monday where the markets lost 20% of their value. Now, think of it like this, if you invested 10K and it rose 226% to 22,600 over the 5 years between 1982 and 1987 that one day, knocking 20% off the value would cost you $4520, bring your gain down from 226% to $18,080 or 181% Gain overall for the period.
The only real periods of impressive stock market gain over history have come after stock market crashes, timing the market correctly would make us all millionaires. The problem always is, we can’t know when it will happen.
Risk is not an absolute term when considering financial investments, it is a term referring to statistical probability. As the market ticks upwards, the risk of the market going downwards, as it regresses towards the mean increases. Consumer confidence is very weak currently and knee jerk reactions to socio-economic drivers appears at an all time high. People want to squeeze that last dime out of the uptick in profit, these are the people that lost money last time around and probably missed out on the markets return. But when it starts to tick downwards again you can believe it will be a fast and direct path downwards.
The key to protect against another crash is keeping enough money in cash or cash equivalents to be able to protect your investment loss. For example, if you have a portfolio of $100,000 in the stock market, if it crashed by 30% but you set aside a sum equal 15% of your portfolio in cash, you could then switch it into stocks at the lower price and it would dollar cost average to repair your holdings. Then when it returns to the present level you will have protected your downside and increased your wealth.
If you have a portfolio that is too large in relation to your income (such as for a retiree) then this is why you need a defensive asset allocation and cannot be too heavily invested in stocks – you need bonds or cash so that if everything tanks you are able to double down your investment to repair the losses when the market ticks back upwards.
This week I am shifting from 90% stocks 10% bonds to a 50/50 holding, my risk tolerance is such that I will stay in stocks for a little more potential upside, but I am pulling out half my money, ready to jump back into stocks should the market drop to a more reasonable level.
I do not advocate holding active funds at all, and I would suggest that you examine your holdings for savings using the Personal Capital portfolio analyzer, this will suggest lower cost alternative funds to save you money. However, I would advocate an active attitude to the market when considering where you are stashing your hard earned savings, so you don’t buy high and sell low.
Sign up here for a free account with Personal Capital, and check your own account for positions that are like this today. Getting started is simple and it only takes a couple of minutes to be up and running, you can analyze your portfolio today, so that you can save more of your money for tomorrow.
– Please note that this is an affiliate link for Personal Capital and if you do decide to sign up I may be compensated by them. I do appreciate your support, and I am a customer of Personal Capital and I endorse them because I think they add real value to my finances, I have saved thousands in potential fees by swapping out legacy Funds with low cost alternatives that these guys identified in my portfolio.
Leave a Reply