Sunday, June 7, 2009

An Investing Pitfall: Losing Your Nerve

This is a Sunday feature looking back at selected articles from the early days of this blog before readership had ramped up. Enjoy.

Pundits, friends, and acquaintances confidently drone on about interest rates, the balance of trade, commodity prices, and the impending doom in the stock market. History tells us that when stock prices have been falling, the negative predictions increase. There is no reason to believe that these people know any better than anyone else whether stocks will go up or down in the short term. Anyone who could actually predict where the stock market was going in the short term could easily make a fortune fast.

Some successful investors say that one of the best times to buy is when the masses agree that stocks are doomed. This barrage of negative news about the stock market leads to a common problem for nervous investors: selling when prices are low. If the stock market then rallies, these investors lose out. I’m not advocating waiting with your cash until the world seems to be crashing down and then buying in either. This kind of market timing works for few people.

If your investments are keeping you up at night, it could mean that you are listening to too many predictors of doom, or that you have too much of your money in stocks rather than bonds. As long as you don’t need the money for a few years, there is no reason to be nervous about short-term market fluctuations.

3 comments:

  1. "As long as you don’t need the money for a few years, there is no reason to be nervous about short-term market fluctuations."

    This does seem to be the standard. It's accepted as truth by all advisors, journalists, money managers.

    But it is reasonable? I agree that it is better than trying to time the markets. Much better. But, isn't there some reasonable middle ground?

    Why don't investors insure their portfolios as they insure homes, cars, and other valuable property?

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  2. Want to Retire (John 789@shaw.ca)June 13, 2009 at 11:44 AM

    If I have say $300,000 and I don't need to touch it till I'm 65 (ten years from now) what is the minimum I could expect it to be worth in 10 years if I follow your advice (i.e. not be nervous about the markets fluctuations between now and then)?

    I need to know the answer to this question.

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  3. John: As you've asked the question, the answer is zero. All investments could go to zero over the next 10 years. One can imagine any number of scenarios that would cause this. Maybe squabbles over North Korea will draw the US and China into nuclear war, and the US and Canadian governments will fail and all Canadian and US dollars will become worthless making all stocks, bonds, and cash worthless. There is no certainty in life.

    Unless your situation is different from the typical case, you won't actually need the whole $300,000 in exactly 10 years. You will need a slice of it in the first year, another slice in the second year, etc. If you put it all in government bonds now, you'll be disappointed to see how little you can spend each year and have it last until you're 90. Some number of years in advance of your retirement, you'll need to shift the first year's worth of income into safer investments (like government bonds), and a year later shift another year worth of income, etc.

    ReplyDelete