Lately stock prices have skittered around. They peaked on Aug. 6 at 8,259 on the Dow Jones industrial average and since then have tumbled and twirled like a pack of monkeys on grease. Some gurus say volatile markets point up; others say they point down–the usual stuff. After a week of more gains than losses, stocks closed just 4.1 percent under their August high.
So how about it? If you own stocks, should you stick or sell? Buy more or bet that by waiting you’ll get a lower price? If you’re new to investing or bailed out two years ago, have you missed a once-in-a-lifetime chance to get rich quick? If I tried to answer these questions I’d just be flapping my lips. This market is well beyond anyone’s longtime experience of how stocks behave.
Limit risk: The one smart thing you can do today is limit your risk. ““Yet the public is not aware of any risk in stocks,’’ marvels economist Peter Bernstein, author of ““Against the Gods, The Remarkable Story of Risk.’’* That’s the dangerous legacy of the ‘87 Crash and the ‘90 Crashette. Both markets carried the message that downturns are brutal but brief–a pause guaranteed to propel your investments to incredible new heights. Today we hold this truth to be self-evident: if we stay in stocks we will retire rich.
That hypothesis probably isn’t wrong if you stay there long enough. Over rolling 20-year periods, the stocks in Standard & Poor’s 500-stock average haven’t lost money since 1926 (with dividends reinvested), according to the market-research firm Ibbotson Associates in Chicago. Over 10-year periods, they lost money only 3 percent of the time. The farther away your retirement, the safer stocks appear to be.
Perversely, however, the longer you stay invested, the riskier stocks become. At 45, you’ve got an apparently ““safe’’ 20 years ahead. But at 60, with retirement five years away, your chance of losing money has climbed to 10 percent–a number clearly visible on the worry screen. After that, your risk of loss increases rapidly.
What’s more, we cannot possibly foresee our lives in 20 years. We’re all hoping to roll in glorious profits from the Dow. But what if there’s an oil war in the Middle East? What about this year’s visit from El NiNo, that warm ocean current that diddles with weather patterns and threatens to damage crops? Any number of other ills may be lurking unannounced. The farther ahead we plan, the greater the chance that Fate will shove a stick in the spokes.
Stocks tend to ““regress to the mean,’’ Peter Bernstein says. The mean shifts around, which foils the seers. Still, it’s generally true that after years of high returns we’ll get some years of low returns, yielding a payoff somewhere in between. The S&P stocks have averaged 10.9 percent annually since 1926, 12.4 percent since the end of World War II and 17.6 percent since 1982. Assuming they regress to a lower mean, some droopy years await.
That’s not what the boomers want to hear. They’re pouring some 70 percent of their savings into stocks, reports the brokerage Sanford C. Bernstein & Co. Such devotion suggests they don’t perceive a serious threat. Alas, the world is ““nearly reasonable, but not quite,’’ wrote the essayist G. K. Chesterton at the turn of the previous century. You can measure the world’s exactitudes, but a secret ““wildness lies in wait.’’
Denying that wildness is the worst possible way of approaching stocks, says psychoanalyst William Nixon of Birmingham, Mich., who lectures to financial planners and finds them too confident by half. People make bad decisions when they come upon danger unprepared.
Intel Envy: None of this means you should sell your stocks and nestle into bank accounts. One of many possible outcomes is that stocks might soar again. If you’re not in the game, you’ll suffer classic Intel Envy: grinding your teeth while your stock-happy neighbors rake in lucky capital gains. Intel Envy leads to bad decisions, too. You plunge, in hopes of ““catching up.''
With the market this high, however, the answer is not to plunge but to reassess. How much can you afford to lose of the money you’ve got at risk? To protect yourself and your family:
Don’t hock the farm. Divide your life into a safe zone and a risky one. Homes should be kept safe. A classic bad decision is to borrow against your home equity and fling the money into stocks. Even if it works it’s wrong, because you took too big a chance.
Don’t overinvest. If you have any money in stocks that you’re going to need within the next five years, get it out right now, says Michael Stolper, whose San Diego firm finds money managers for people of wealth. Stolper’s rule of thumb may sound conservative to you. But during that period, a downturn might hit and not recover by the time you need the cash. Retirement funds can stay in stocks. Real money needs to be more at hand.
Age isn’t even the critical factor when choosing how much to commit to stocks, says planner John Allen of Arvada, Colo. The key decision is how long you’ll be able to leave the money alone.
Don’t stake everything on stocks. Today’s incredible passion for easy gains could be your personal ““crack of doom,’’ says market strategist Raymond DeVoe, author of the witty and popular DeVoe Report. He defines that ““crack’’ as the moment when you know, for sure, not only that you are going to lose money but are going to lose a lot more money than you can afford.
Prepare for a sudden, unexpected change in play. Markets always surprise the people who try to psych them out. U.S. stocks–the obvious worldbeaters now–looked like losers 15 years ago. Fifteen years from now, you might be glad you bought foreign stocks or even bonds. Diversification doesn’t promise the best returns, but it keeps you in whatever game is going on.
