Great stock market returns can be just as dangerous for investors as a stock market crash.
Stocks have posted excellent returns for 2013. The DFA US Micro Cap Portfolio, a fund we use for our clients’ allocation to small, US companies, is up 35.7% for the year-to-date, while large US company funds have posted returns between 26% and 33%. Even the international stock funds we use in our client portfolios are up 18% to 27%. October was also the busiest month for U.S.-listed initial public offerings since 2007. Last week Twitter posted a 73% gain on the day of its IPO. All this positive news about stocks is giving people amnesia.
Monday’s Wall Street Journal quoted Chris Rouk, an investor who remained out of the market from 2009 until recently. Now, he said, he wants to get more aggressive. There are a lot more where he came from.
Lipper, a company that tracks mutual fund flows, reported on October 17th that $17.9 billion was invested by individuals moving back into stock funds in the month of September alone, representing the third straight month deposits have outpaced withdrawals.
The panic felt during the Great Recession is becoming a distant memory for many. From September 2008 until April 2009, I saved select copies of the Wall Street Journal to help me remember what it felt like to be in the middle of a market meltdown. The headline that speaks to me the most is a September 21, 2008 special report: ECONOMY ON THE BRINK! With a photo of U.S. Treasury Secretary Henry Paulson speaking with reporters and a list of all the failing financial institutions bolded below, things looked pretty dire. The Dow Jones Industrial Average continued to fall until it reached its low point of 6,547 on March 9, 2009.
From September 2008 until March 2009, we worked to keep our clients from bailing out of stocks. We were able to rebalance portfolios by selling bonds at gains, and bought stock funds that were trading at discounts of 53% to 37% from their share prices a year earlier. Today, the DJIA is up over 140% from March 2009, and people are starting to feel better about stocks. The problem is, they missed nearly 5 years of excellent stock market returns, and have forgotten that markets can have scary corrections.
To quote the WSJ investor, “There might be small corrections here or there, but the stock market always seems to spring back up.”
Unfortunately, selling stocks when the markets are in the depths of panic and buying back into them when it feels safe to do so, is a pattern that many people follow, and it’s the reason most investors don’t experience the high returns they see published in articles and newspaper ads. If you buy in after the returns have already passed you by, you are setting yourself up for failure.
We know over long periods of time, stocks will provide larger returns than bonds and cash. But in one to ten year stretches, we will experience market drops. We just don’t know when.
Having a discipline in place that calls for selling investments at gains, before those gains go away, is a far more successful strategy than investing when it feels good again. And buying stocks when their prices are low, even if it doesn’t feel comfortable, is a much better plan for accumulating long-term wealth.