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Rational Investing: Why I Don’t Sweat the Big Stuff


It’s not easy being rational.

When your 401(k) drops several thousand dollars in a few months, when the people on your TV are chattering about another recession, when newspapers lead with headlines a fiscal cliff (whatever that is) putting corporate investment on hold…it takes a great deal of resolve to sit there and do nothing.

But as an investor, much of the time, that’s exactly what you need to do.

Recently I’ve been having flashbacks to the beginning of the Great Recession four years ago. The airwaves were filled with stories of stunned investors reeling from having lost 30 or 40 percent of their life savings.

It’s hard to fathom losing that much money and watching dreams disappear with the blip of a stock chart.

It’s tragic.

But what’s more tragic, still, is that many of those same investors turned around and sold the stock they had left.

As you know, it’s nearly impossible to earn a decent return on your money these days. The best savings accounts and CDs yield less than 1 percent while treasuries and other bonds can’t do a whole lot better. So those hard-hit investors who cashed out at the bottom would be lucky to have earned a 2 percent annual return since early 2009.

But consider this: in February 2009, I bought shares of SPY, an exchange-traded fund that tracks the S&P 500. Since then, the S&P 500 is up about 81 percent.

Since the crash of 2009, the S&P 500 has returned 81 percent; gains that only went to investors who stayed in the game.

This is an extreme example using a lucky stock purchase near the market’s bottom in March 2009. Although I invested then because I try to buy more stock during markets declines, I didn’t try to “time” the market’s bottom (nor do I advocate that anyone attempt it).

But if those investors who sold their beat-up portfolios in 2008 and 2009 had remained in the market, they just might have recovered much of their wealth. Would some of them still have to put off their goals? Probably. But at least they’d still have a shot at reaching them.

Right now, there is a lot of pessimistic news as the world waits to see how Washington will handle the approaching fiscal cliff. Indeed, our country needs to tackle its own fiscal problems; the United States has too much debt and not enough income. How our lawmakers handle the problem will send ripples through the economy and the stock market. WhyBut we can’t control that. So this month’s sour grapes are no different than the many before it. And my advice is the same: Just ignore it. Well-diversified investors who stick this out will come out just fine, whatever happens.

It’s a time to be rational. It’s a time to wait and see. Not that anyone said it would be easy.

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

Comments

  1. My thoughts exactly. I keep my focus on the long term and do my best to tune out the short term. It’s not easy but it’s what has to be done. I too feel bad for those that lost a lot, got scared and now are sitting with what they have left in cash. If they had stayed in the market, they would have it all or close to it back.

    Now that they are too scared to invest in the market, they risk allowing inflation eat away at what they have and never having enough to retire. They think they are playing it safe, but staying 100% is extremely risky.

  2. What is your strategy on buying during “market declines”? I invest a set amount automatically each month, and for rest I’d like to invest, I wait for the stock market to fall a few days in a row and then I keep investing as long as the market is falling. How do you do it?

    • David E. Weliver says:

      Basically the same as you, Ross. Being self employed, I only draw part of my total earnings into a personal checking account each month for spending and routine saving. From those “paychecks”, I automatically invest a small amount monthly. Then, if there’s a market decline, I’ll disperse additional earnings from my business to myself and invest the funds then.

      • Where do you put that small monthly amount? I am maxed out on retirement and was interested in investing a small monthly amount outside of that context, but was uncertain where to put it.

        • David E. Weliver says:

          A couple places. I have a SEP IRA for retirement which has pretty high contribution limits, but I do still hit them. After that I have a taxable brokerage account that I buy ETFs in and I also have an account at Betterment for investing for shorter-term (< 5 yrs) goals.

    • Another way to do it is to rebalance your portfolio. If you have a stock to bond ratio of 70 to 30, then if stocks plummet your ratio will change to something like 60 to 40. Just sell off some of your bonds and buy stocks to get the ratio back to where it was. Instead of selling bonds you could also make sure all new money being invested gets put into stocks until the ratio is where you want it.

      Periodic rebalancing is very simple and it forces you to buy low and sell high.

  3. Excellent article. Long-term investing in the stock market outperforms bonds, gold, treasuries, and, of course, CDs/money market.

    Deutsche Bank recently published its annual Long-Term Asset Return Study, which tells the story:

    Asset……………………………Average Annual Real Return, 1838-2012
    Stocks………………………….6.49%
    Treasuries…………………….2.77%
    Corporate Bonds……………2.72%
    Gold…………………………….0.35%

    It’s a basic human tendency to avoid investments that are falling and buy investments that rise. As you point out, the easiest way to avoid this is to ignore the hype and dollar cost average over time. To gain the overall average market return, about 8% for the S&P 500, one has to hold stocks for many years. The average stock these days is held for about seven months. That is nowhere near long enough, and it helps explain why so many investors, amateur and professional, underperform the market.

    In the short-run, stock prices are bounced around by fear, greed, rumor, some facts, and oddities in group behavior. That means as investors we should never get too high on the good years, or too low on the bad ones.

  4. As J. P. Morgan once said, “the best time to invest in when there is blood in the streets.” You have look at a decline as a buying opportunity. If you are under 30, then your investment horizon is over 30 years. You should not be worried about selling stock, but rather focus on accumulating positions at opportune times. As David points out, you shouldn’t try to time the market outright. However, you can maybe put extra savings into the market when it is down.