“First I was bullish, then bearish, then brokish.” – Milton Berle
Common Sense Reader Mailbag: I completely sold out of the stock market. Now I’m scared I made the wrong decision and I’m going to miss out on future gains. What should I do now?
This is a question I’ve heard a lot over the last couple of years as stocks have continued to perform well. With the memory of the 2008 crash in the back of our minds, it’s easy to get nervous when the market hits new highs again.
It’s common to have this kind of reaction when making such a large move within your portfolio. If you have read my past posts you know that I’m not a huge fan of market timing. I think you are much better off setting up a simple common sense investment plan that focuses on your strategic goals with an asset allocation process at the center of that framework.
In the immortal words of Larry David, having said that, our two worst enemies (fear and greed) do take over from time to time and we make short-term moves that aren’t in line with our long-term goals.
If you make the mistake of getting completely out of the market then you have a couple of options. Now, when I say you made the mistake of getting out of the market I’m not talking about whether or not it will help you in the short-term. Because it is possible you will get lucky and sell at the very top. But this is probably the worst thing that could happen to you. If you happen to time it right your overconfidence will grow and you will start thinking you can do this on a regular basis.
Tops and bottoms in the stock market are easy to spot in hindsight. But they can come and go without warning. The old saying is that is takes a lot longer to blow up the balloon than to let the air out (tops last longer than bottoms, but losses can come quickly). In fact, since 1928 the S&P 500 has closed at a new all-time high 1,024 times (and counting) or 4.8% of all trading days.
Most of the time we are just somewhere in the middle of a top or bottom. And being stuck in the middle causes us to want to make moves with our money even if doing nothing is the correct answer.
Here are some facts from Josh Brown over at The Reformed Broker to put the stock market into perspective. Over the last 110 years the stock market has averaged three 5% corrections per year, one 10% correction per year and one 20% correction every 3.5 years. Have fun trying to figure out which one it’s going to turn out to be when the market does correct.
Market timing by trying to sell at the top and buy back again at the bottom means that you have to be right twice – when you sell and when you buy again. Both of these decisions are very tough to make consistently, let alone together.
Staying on that path turns you into a speculator as opposed to an investor. And that is not a game you want to play. Over the long run you will turn your investment process into a casino game and you don’t want to be gambling with your retirement savings. Carl Richards at Behavior Gap has a very simple drawing that shows you an easy way to go broke in the stock market:
Anyways, now I can get off my soapbox and give you your options about what to do if you do completely get out of the stocks through market timing. Because letting our emotions get the best of us is part of human nature and these things do happen.
Let’s assume that you have an asset allocation plan in place but you decided to alter it because of your fear of a stock market meltdown. So you have wildly deviated from your plan in the near-term and you are sitting in all cash and don’t know what to do going forward.
You could just turn around and buy everything back right away but that will not calm your nerves either. In this case the best course of action is probably to come up with a plan and stick to it no matter what the market does. Would it be great if you could put all of your money back in after a 20% correction? Yes, but the market doesn’t always cooperate with our desires.
Simply stick your cash into your investment plan. You could pick a periodic set of dates (monthly, quarterly, or semi-annually) to put your money back to work in small chunks. This takes out the emotion of trying to guess the correct time to get back in. However you put the cash to work it will be impossible to time it perfectly so don’t even try.
Simply break up the cash proceeds into equal amounts and slowly put it back into the market over time. This will be just like dollar-cost averaging into the market on a regular basis as you do with your retirement contributions.
For example, break your cash into 10% or 20% increments. Then on the first day of each month (or whatever period you choose) put that amount back into the market. The actually day doesn’t matter but the process of choosing the same day over time will help you stick to the plan.
This forces you to be disciplined and not let your emotions cloud your purchase decisions like it has clouded your sale decision. The amount and period don’t matter as long as you are comfortable with the percentage and time horizon to get back in.
Don’t have an asset allocation plan in place? Now is as good of a time as any since you have all that cash at your disposal. Pick a mix of stocks, bonds and cash that aligns with your goals, risk profile and time horizon of your investments. If you are jumping in and out of the market it’s obvious your short-term behavior isn’t meshing with your time horizon as a long-term investor. Come up with a plan that takes into account your assets, salary, age, future needs, etc. and stick to the plan.
You can also use this same exercise when you receive a financial windfall like an inheritance or performance bonus from work. For once let the volatility of the stock market work in your favor and spread out your investments at different market levels. Coming up with a process after you get out of the market will help you create a more comprehensive plan that you can use with future investments. And aligning your risk tolerance with your investment choices will allow you to stick with your plan in the future without making decisions that will make you nervous.
Stocks will go down at some point in the future. Over your lifetime they will go down many times. Market timing is not the answer. How you react to these situations will have a large impact on your long-term returns.