Yesterday, I mentioned that
I think the stock market might crash.
I’m not predicting a crash — I just think the odds of this happening in the next couple of years are higher than usual (logic here).
More importantly, I think the odds are very high that, even if the market doesn’t crash, stocks will return far less over the next decade than the double-digit percentages they have returned in the past four years.
In light of that view, several readers have asked why I am not selling my stocks or even going short (betting on a crash).
After all, if I think there’s a “decent chance” of a 30%+ crash in the next year or two, wouldn’t this be a wonderful opportunity to make (or at least save) some money?
That’s a perfectly reasonable question.
Here’s why I’m not selling my stocks or going short the stock market:
* My portfolio is already well diversified. My savings are composed primarily of low-cost index funds holding stocks, bonds, cash, and real-estate. If the stock market collapsed, this diversification would cushion the blow. It would also (I hope) keep me from panicking and selling near the bottom. (This is a real risk, one I occasionally succumbed to early in my investing career.) I also have enough of my portfolio in cash that, if the market does crash, I’ll be able to rebalance into stocks at a much lower level.
* I never invest money in the stock market that I need to use in the next 10 years. The stock market does crash occasionally. And the last thing you want is to have to sell your stocks during the period when the market is “crashed.” If the stock market crashes permanently, or we get in a Japan-type situation in which stocks remain clobbered for decades, then, yes, I’ll be bummed I didn’t sell some now. But otherwise I expect any crash to be relatively temporary, just as the crash of 2008-2009 was.
* The outlook for other asset classes over the next 10 years is no more attractive than it is for stocks (and, in some possible scenarios, it is worse). If interest rates rise back to normal levels, bonds will get obliterated. Cash is earning nothing. Real-estate is also expensive by many measures. So the last thing I want to do is leap from the pot into the fire.
* There seems a reasonable likelihood that inflation will accelerate at some point over the next decade, and stocks are a good hedge against inflation. Unlike bonds and cash, stocks are “real” assets. They represent an ownership share in an enterprise whose business will adjust to inflation by raising the nominal level of prices, wages, and profits. Stocks don’t necessarily do well in high-inflation environments (stocks were flat in nominal terms from 1966-1982 and dropped considerably after adjusting for inflation). But they do better than bonds, which get demolished.
* Just because I think there’s a “decent chance” of a market crash doesn’t mean I am highly confident there will be one. I am never highly confident of any short-term market behaviour. And I would suggest that anyone who is highly confident about short-term market behaviour either doesn’t have much market experience or is deluding themselves. I am reasonably confident that stock returns will be crappy for the next decade — because all the valid valuation measures I know of suggest that they will. But sometimes things change fundamentally and the old rules no longer apply. And it’s certainly possible that it’s “different this time.” (That, by the way, is why I’m not 100% confident that returns will be crappy. If you ever meet someone who knows what the market is going to do, please send them my way. I always assumed this person existed, and I spent my decade on Wall Street looking for him/her, but I never found him/her.)
* I have learned the hard way that market timing is very difficult and is generally a terrible idea. It is really hard to correctly “time” major market reversals. (I learned this as an analyst during the dotcom crash in 2000, and my mistake cost me and my clients a fortune.) And it is really, really hard to correctly time two major market reversals in a row, which is what I would have to do for it to be a smart idea for me to dump my stocks now. Specifically, if I sell now, and the stock market does, in fact, drop 30%+ from this level in the next couple of years, I will then have to figure out the right moment to get back in. (Given inflation, remaining on the sidelines forever would be a disaster.) If the market drops, say, 25%, it will be because things look so terrible that it will look like the market is going to drop another 25%. And who wants to buy only to have the market crash another 25%? If I set a hard “buy” floor at 30%, meanwhile, the market will no doubt drop 28.8% and then skyrocket, leaving me alone at the station as it rolls away.
* The market might not crash. Instead of crashing over the next year or two, the market might rise another 10%-30%-50%-100% and then correct the “imbalance” by parking in place for 10-20 years. It will be psychologically very difficult for me to buy back in at a higher level after selling here, especially if I am still worried about a crash. (And if I wait to buy in until I am NOT worried about a crash, I’ll be waiting for Godot.)
* If I sell now, I’ll have to pay taxes. Thanks to my indexing strategy, I have captured every point of the move up from the 2009 market low. When markets crash, I also buy more of them, so I was lucky enough to get some new stock in 2008 and 2009 at much lower levels than today. So if I sell now, I’ll have some capital gains taxes to pay. (I did, stupidly, “rebalance” out of some stocks in 2011 or so, in part because I persuaded myself that we were experiencing a sort of sucker’s rally. That dumb-arse move has cost me a lot of money between now and then and reaffirmed by conviction that market timing is idiotic. But, on the bright side, I have fewer embedded capital gains taxes to pay.)
* Oddly, the best thing that could happen for my long-term stock returns would be for the market to crash 50% and then stay crashed for 5-7 years. I reinvest dividends. So if the market drops by, say, 50% over the next year, and then stays at, say, DOW 7,500 for 5-7 years, I will get to reinvest 5-7 years worth of dividends at half the price per share that I am paying today. This will result in my accumulating twice as many new shares over the next 5-7 years as I will if stocks stay where they currently are. Then, 5-7 years from now, when the stock market finally begins to recover, these new shares will act as a sort of portfolio turbocharger, boosting my returns.
In short, the only thing I am really worried about as a stock-market investor is a permanent crash. And if the stock market crashes permanently, it will likely be because the United States has experienced a communist revolution in which all private assets are seized or some other cataclysm. And if that happens, I’m going to have bigger things to worry about than my stock portfolio…
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