Now Is Not The Time to Do Anything Stupid
March 2000 was one the worst times in history to buy stocks. Depending on how you calculate it, that may have been the single worst time ever, actually.
It was the peak of the dot-com bubble, when the P/E ratio on the S&P 500 was more than double its long-term average. Stocks soon crashed almost 50%, recovered, and crashed again in 2008.
But "this too will pass," as the saying goes. And it did. Someone who bought the S&P 500 in March 2000 and held through today has earned a 61% return on investment, including dividends. Not a king's ransom, but not bad, either -- about double the rate of inflation.
But we know the average stock investor hasn't earned anywhere near 61% since March 2000. Using money-flow data from Dalbar, with an estimate of returns earned year to date, the average individual stock investor has likely earned a total return of roughly 19% in that time.
The average investor has underperformed our idiot friend who bought at the peak and held on tight because the average investor is constantly attempting to time the market, bailing out when he or she think losses are ahead, and piling in when thinking gains are due -- always at precisely the wrong times. That constant fidgeting and temptation to "do something" leads this investor to bad behavior over and over again.
Keep this in mind, because with stocks at all-time highs, more smart investors are asking if stocks are overvalued and due for a crash. Take these headlines from the last week:
"The Fed-Induced Stock Market Bubble Continues"
'"Definitely a bubble brewing' in stock market: Pro"
"Tech Stocks: A Bubble Just Waiting to Burst?"
People were saying the same thing about stocks three years ago, but let's assume these headlines are right and a new crash is right around the corner.
What should investors do?
If you understand the history of average market returns versus average investor returns, I think your answer has to be, "nothing different." Buy good companies. Diversify. Rebalance once in a while. Hang out with your kids. But nothing stupid.
Stocks will crash again someday. That's the short-term price you pay for superior long-term returns. But there is no evidence that trying to predict and avoid those crashes can help your long-term returns. People just can't do it consistently, and end up shredding their long-term returns in the process. The biggest market gains over time accrue to those who are the most patient, not those who try to be the smartest.
There's something else odd here. While stocks are up up big since 2009, they have barely kept up with inflation over the last six years. Why are so many professional investors convinced we're in a new exuberant bubble? Investor Eddy Elfenbein had a great tweet the other day that helps explain it:
A bubble is a bull market in which you don't have a position.
-- Eddy Elfenbein (@EddyElfenbein) Nov. 2, 2013
While the S&P 500 gained 29% from 2008 through January of this year, the average equity hedge fund was up less than 9%. Professional money managers have, on average, been humiliated by the market over the last five years. Why? Likely because they've been anticipating another financial crisis, waiting in cash and bonds, and being disastrously wrong in the process. No money managers want to go to their investors and say they were wrong, so instead they say stocks are overvalued and we're in a bubble, which makes their avoidance look prudent.
Don't mistake this for bullishness on my part. I'm less bullish now than I have been in a while, only because that's what you should do when stocks grow faster than earnings. But there nothing inconsistent about staying invested even when you think stocks might be pricey. Trying to avoid bear markets has done far more damage to individual investors than riding them out.
"Timing the market is a fool's game," investor Nick Murray once said, "but time in the market is your greatest natural advantage." Now is not the time to do anything stupid.
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