The headlines scream at us about the strong financial data being reported, spurring the stock market to climb higher and higher. For some, this elicits a sense of dread, while others are looking to buy into the force of the rally. Some are wondering if they're too late, while others are allowing new found optimism to believe that this new tree will indeed grow up to the sky, forever and ever and ever upward. Before we get caught up in the words and the feelings, let's tap the brakes a bit and examine how our beliefs guide our actions which causes us to make really bad decisions.
When equities are out of favor, due to recession or other economic or non-economic occurrences, and the broad market prices of stocks fall-people believe that the condition is permanent and therefore the only way to hold onto a few cents on the dollar is to sell out and stash their change under the mattress. When full-fledged panic sets in, then the velocity of this action speeds up and takes on a life of its own, becoming a self-fulfilling prophecy, while those who were "smart" enough to get out waving their change purses just to prove their brilliance.
Fast forward to a point in time after the recession, when the economy has come back sufficiently to provide enough comfort to where investors feel that if they don't jump back in with their few remaining coins, they will have missed the market and will show off their lack of financial acuity.
Let's look at some numbers:
On October 9, 2007, the Dow closed at 14,164
On March 5, 2009, the Dow closed at 6,594( -53.45%-from Oct 9, 2007)
On June 26, 2009, the Dow closed at 8,438 (+27.97% from March 5, 2009)
On March 22, 2013, the Dow closed at 14, 512 ( +71.98% from June 26, 2009)
It is safe to say, that the investor who sold during the panic time of the recession is not happy, having seen their wealth diminish due to their own emotional behaviors. It is also safe to say that the investor who hung on and didn't panic and sell, while not winning awards for high returns, is unscathed by the disaster.
Some might look at the numbers and decide that they have already missed the market and therefore will continue to earn 0.0% on their money funds rather than face another market disaster. Before you assign yourself to financial purgatory, maybe it's time to rethink your belief system and rely not on your emotion or your powers of financial "reasoning" but by redesigning your investments based on some very simple rules.
Rule #1: Markets move up and down and not always together.
Rule #2: Your true time horizon should be a significant guide in making investment decisions
Rule #3: If you have a long time horizon (i.e.you will not need to cash in your investment all at once in the near or mid-term), what support system do you need to help you get through the inevitable down years that happen? Make sure you create it before you plunk your money down for yet another try at the brass ring.
Rule#4: Expectations will kill you. If you buy a stock, expecting it to go up-you're setting yourself up for failure. While it MIGHT rise in price, it will not do so simply because you made the buy decision.
Rule #5: Diversification works. It isn't sexy, nor will it give you bragging rights at the golf club or cocktail party, but proper diversification provides you with a better chance of not getting killed in the market than if you try selecting a handful of stocks off of some "experts" (or worse, journalists') list.
Rule #6: The markets are not the problem-you are!
If you need further proof, try this one on:
The 20-Year Annualized Returns from 1992-2011:
S&P 500 7.8%
Inflation 2.5% (CPI)
Average Investor 2.1% (Dalbar, Inc)
All asset classes and inflation outperformed the average investor's return. Why? Behavior-we think we are able to intellectualize our decisions, whereas in fact, our decisions are emotional.
Is this a good time to buy? I don't know-it depends on your ability to curb your emotions from fear and panic to unbridled optimism and stay the course through all market conditions. It's up to you to behave better than the "average" investor.