The U.S. stock market, measured by the Standard & Poor’s 500 index, began this week less than 8 per cent below the all-time high it reached in 2007. Other markets around the world have more ground to make up, but virtually all are far above the lows they reached in the panic of 2008-09.So how is your portfolio doing?
Even if you were hammered by the crash, you ought to be in pretty good shape if you followed two simple rules during the past five years: First, you did not panic and sell your equities amid the general rush for the exits, and second, you were diversified enough to ensure that your investment results would track the market’s overall trends.
These were not Wall Street secrets. My colleagues and I, and other advisers, proclaimed them at every opportunity throughout the crash, yet thousands of people succumbed to fear and doubt and sold at the market’s lows. Many were amateurs who repeated a long-familiar pattern of buying at market tops and selling at the bottom, but plenty of professional money managers, pension fund administrators, endowment trustees and others who should have known better also dumped equities at the worst possible time. They were convinced that recovery could not come any time soon, or that they would be fired for holding on in the belief that it might. We are all human and subject to the foibles of human psychology.
I vividly remember a conversation with one client who wanted to sell his stocks early in 2009, when the S&P was around 750 and still falling. He told me he believed me when I assured him the market would recover at some point, and he promised to buy his stocks back when the index reached 1,000.
“Let me get this straight,” I replied. “You don’t need cash. You believe the market is going to recover. But you want to lock in your losses right now, and guarantee that you will miss a 33 per cent rebound?”
“Yes,” said the client, who was an experienced and intelligent businessman.
“Why would you want to do that?”
He had no answer because there was no answer – or no rational answer, at least. He was behaving irrationally, and he realised it. Fortunately, this man did not really want to act on an irrational impulse that was sure to hurt him in the long run. He took my advice to sit tight. Most of our firm’s clients did.
More than anything else we do, our ability to persuade clients not to act against their long-term interests out of undue fear or exuberance is where we earn our keep as financial advisers.
Most people assume that the recent past is a strong predictor of the near future. They therefore expect world-beating results from last year’s top-performing mutual fund (or sports team, for that matter – this psychology is not confined to finance). Sometimes a champion does repeat. More often, it does not.
All trends continue for a period of time; that’s how they become trends. Following a trend can work for a while. That is why so many people decided to become day traders during the Internet stock bubble in the late 1990s. They convinced themselves that their profits proved they were smarter than others in the marketplace, when all it really showed was that it was easy to make money when stocks only moved in one direction. A few years later, nearly all those traders were doing something else for a living.
From the Dutch tulip craze in the 17th century, to the October 1929 stock market crash, to the end of the housing boom a few years ago, market trend reversals have consistently defied people’s attempts to time them.
We can’t predict short-term stock market directions, either. The S&P index began the year around 1,250. Since that time, we have seen Europe’s credit crisis spread to Italy and Spain; continued lagging growth and high unemployment here and in Europe, with a marked slowdown in China and elsewhere; a legislative deadlock in Washington that is bringing us closer to the dreaded “fiscal cliff;” a rising threat of conflict between Israel and Iran; and an explosion of anti-American anger across the Middle East.
And with all that, the S&P is up more than 15 per cent this year.
Unless the market reverses itself soon, we are likely to see a slow but steady return to stocks among individuals and institutions. Ben Bernanke and the Federal Reserve certainly hope so. They are choking the life out of interest rates in order to drive money into more volatile investments, like stocks, in hopes of triggering a wealth effect that will encourage consumers to spend. Just as so many people ignored advice to stay calm when the market crashed, they will ignore advice not to over-expose themselves to stocks just as the market gets more expensive.
Success comes from having a long-term plan and sticking with it. This principle is not a Wall Street secret either, but not many people have the discipline to follow it.
In October 2008, as the panic neared its peak, my firm placed an advertisement in the Scarsdale, N.Y. newspaper to try to be a voice of reason.
“Nobody ever got rich buying at the top of the market, did they?” we wrote. “Just two years ago, money itself was the only financial asset that was cheap. Prices of everything else, from condos to collateralized debt, were bid up on the tide of easy credit. Now the situation is reversed. Solid assets are being sold at bargain prices. Nobody can say whether this is the bottom, and prices may yet fall further. But the odds are good that when we look back at this period in five or 10 years, we will see savvy investors who succeeded by buying when everyone wanted to sell.”
I think it was pretty good advice. I wish more people had taken it.
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