Panicking about the stock market’s sudden turmoil?
Here’s one solution that isn’t quite as crazy as it may sound.
Sell everything before the next big downturn. Then reinvest slowly — every three months.
A MarketWatch analysis of the last two bear markets on Wall Street shows that this strategy would have slashed your risks by as much as a third, and would have yielded you much greater long-term profits on the way back up. Less risk, more money. What’s not to like?
Yes, to be sure, this strategy will underperform if the market suddenly turns around and charges to new highs. (And be warned: Oct. 31 is usually the best time of year to buy stocks, possibly because people are so often panicking in the run-up to Halloween.)
But many investors may feel that avoiding big losses is a higher priority than maximizing profits. As Warren Buffett likes to say, the first rule of successful investing is to lose no money, and the second rule is never to forget the first rule. Mathematically, it takes a 100% gain to recover from a 50% loss, so many argue that playing defense is more important than playing offense.
Mathematically, it takes a 100% gain to recover from a 50% loss, so many argue that playing defense is more important than playing offense.
Staying fully invested may also pose an emotional challenge. Investors, say experts, tend to be much more risk-averse than they realize. Not until the market falls do people really know how they feel about losing money. Many are the investors who entered a bear market determined to stay fully invested, and stay “focused on the long term” throughout, only to throw in the towel in the end, often just before things turned around.
We’re not saying the market is about to plunge into the abyss. Merely that it could. Nor are we saying that you should sell and then buy back in slowly at three monthly intervals: Only that, based on the last two crashes, that strategy would have helped even the least sophisticated investor avoid most of the worst disasters.
Opinion is free, but facts are sacred, as the saying goes. I’m in the facts business and that’s all I’m offering. What you do with them is up to you.
From March, 2000 through September, 2002, an investment in the MSCI World index lost 46% of its value (even when you include dividends). But someone who was lucky enough to sell their stocks at the peak, and then reinvested during the slump at three monthly intervals, lost nearly a third less. And when the next bull market began again in late 2002 their cost basis was about 20% lower than the person who had stayed fully invested.
They won both ways.
It was a similar story in the next bear market. From October, 2007 through the start of March, 2009, an investment in the MSCI World index did even worse, losing just over half its value even when including dividends. But someone who, again, was lucky enough to sell at the start but then reinvested at three monthly intervals fared much better: They cut their losses by nearly a quarter, and began the next bull market with a cost basis that was, again, 20% lower.
Curiously, in both cases the strategy of reinvesting every three months seemed to work better than the usual advice, which is to reinvest monthly. Big bear markets last longer, and fall further, than most expect. Investing monthly may feel like it’s going to smooth your returns, but in the past two crashes it left investors over-investing early on, before things got really bad.
None of this involves alchemy or the kind of optical illusions associated with the late Dutch artist MC Escher. It is not a recipe for a free lunch, but maybe for one that is reasonable value.
Nor is this result dependent on selling precisely at the start of the bear market. The key elements to the strategy were getting out early, and getting back in slowly. The worst losses in a bear market are usually right at the end.
Nor is this result dependent on selling precisely at the start of the bear market. The worst losses in a bear market are usually right at the end.
No one knows when bear markets are going to begin, how long they will last or how deep they will fall. Many people will argue you should just stay in stocks and hang on. Peter Lynch, famed former manager of the Fidelity Magellan fund, has said that the average investor has lost far more money over the years worrying about a crash (and, therefore, being under-invested in stocks) than they have lost in a crash.
However, I am repeatedly struck by the gap between financial theory and financial practice. Even very sophisticated investors admit to getting out of stocks too early, or getting back in too early, or too late. Few got out ahead of the 2007-2009 crash in time.
Those that did mostly stayed out far too long and missed a lot of the subsequent rally. “I keep saying I’m going to wait one more day before buying more stocks,” a strategist told me at a party at the<is that Brit speak for last? weekend. Each day the market fell further, he said, and so he put it off yet again.
Perhaps we’re all investing amateurs at heart. How many of us are 100% equities? How many stayed 100% equities through the last two crashes?
And yes, it’s true that stocks have been great investments over the long term. But it’s also true that all sorts of signals which long track records have been flashing amber or even red for some time. Some very smart experts fear stocks are not a good investment at these levels, or that a major crash may be on the cards (or both).
GMO in Boston sees negative medium-returns from here from all major stock markets except those in emerging markets. Research Affiliates in Newport Beach, Calif., doesn’t think the outlook is much better. John Hussman is sounding even scarier than usual.
Make of it what you will.
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