By David Ning July 30, 2014 |
Avoid taking on too much risk just because your investments are performing well right now.
The stock market is going gangbusters these days, with the S&P 500 close to surpassing 2,000 points. As many people are celebrating their paper worth, I can’t help but remember a few short years ago when the S&P 500 dropped to the 600s. While the index may never fall back to that level, bear markets will one day hit us hard again. It’s a good idea to develop a plan for the next bear market now, while your asset values aren’t free falling and clouding your judgment. That way, you will be less tempted to make a permanent move that derails your solid retirement plan the next time the stock market takes a dive. Here are some of the sensational claims that could wreak havoc on your retirement plans if you buy into them during the next bear market:
Someone will claim that buy and hold is dead. Index investing is making many Wall Street brokers unhappy because every dollar invested in a low cost index fund is another dollar gone from the pool that pays them commissions. The next time the stock market dips, you will again hear how buy and hold is not going to work this time and that you need to time the market to be successful. Of course, you are always going to make a killing if you can accurately get out right before declines and get back in after the carnage. Unfortunately, those who succeed in getting out and back in are only the lucky few, while practically everybody else who tries ends up paying extra taxes and missing out on gains that follow. People who sold around 2009 didn’t get the full value of the recovery.
Financial pundits will say that this time is different. While they may be right that the reason for the big decline is slightly different each time around, don’t let anyone fool you into thinking that a drop in stock valuations is permanent. Unless there’s a catastrophe that permanently wipes out huge parts of the world, betting on the world stock market coming back to new highs is a very sure bet. Remember that stocks aren’t only pieces of paper people want in bull markets. Buying stock is buying the right to own a piece of the profits a company generates. If you buy an index, you are betting that at least some of the companies within the index will once again make higher profits, which has always happened because world economies have always bounced back. That’s why you should think very carefully if you sell after valuations go down, because doing so means you won’t be participating in the extremely high chance that valuations will once again march upwards. Stocks have endured the great depression, two World Wars, high inflation and all kinds of asset bubbles and still came out the best yielding asset class over the long term. What makes you think it won’t survive the next shock?
Everyone will tell you that you had too little in bonds. It’s always tempting to reduce your bond exposure in bull markets and increase it during bear markets, when you really should be doing the opposite. Remember in 2009 and 2010 after the big crash when just about everybody was saying that you needed more bonds? If you followed that advice, any dollar moved into bonds then saw a modest increase while stocks rallied hard for about five years and counting. Once you realize the stock market is crashing it is already too late to profitably shift your money to bonds because stock valuations are low. You are severely increasing the odds of buying high and selling low by moving to bonds after declines. The prudent asset allocation strategy may be the opposite. It might be painful to do, but selling bonds and buying stocks after equity values go way down actually increases the odds of outperformance.
To Your Successful Retirement!
Michael Ginsberg, JD, CFP®