Dow 10,000: It’s do-over time!

By Felix Salmon
October 15, 2009
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Remember the grim days of March? You should. Millions of small investors across the country were staring aghast at their brokerage statements, with one thought going through their heads: “I should never have invested in the stock market”. They’d done so on the advice of people who had assured them that stocks always go up over the long term, and then they’d seen their holdings decimated. In hindsight, they decided, they had less of a risk appetite than they needed to have that kind of exposure to the stock market. But selling at the bottom and capitulating to the bear felt impossible.

The good news is that the current stock-market rally has given them a second chance. If you’ve been diligently putting money into stocks for years, there’s a good chance that the current value of your portfolio is not hugely lower than the total nominal amount saved. If you had an idea, back in March, of what your risk appetite really was, then now’s the time to rebalance your portfolio in line with the degree of risk aversion you discovered in yourself seven months ago. If and when stocks drop again, then you really will only have yourself to blame.

Of course, everybody’s individual situation is different, but in aggregate we’ve gone from devastation to mere pain. And when you’re involved in something painful, and you can get out of it, a quiet exit is often the best thing you can do. Of course, stocks could go up further from here. But that’s not the point. Unless you can afford to see your stocks fall, you shouldn’t be invested in them.

You don’t need to sell all your stocks, of course. Some exposure to equities makes perfect sense. But make sure you have a decent cash cushion first. And if you have any kind of debt at all — even if it’s just a mortgage — there’s a strong case to be made that you should pay that down by selling your stocks. Paying down a 6% mortgage is the functional equivalent of getting a guaranteed 6% return on your money, risk-free. (Ignoring the tax benefits of having a mortgage for the time being.) That seems a lot more attractive than buying stocks at these levels.

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Comments
11 comments so far

Run, do not walk, to your nearest broker (PC terminal) and follow Felix’s advice.

Many consumers in the US and are up to their eyeballs in debt and will be paying that down for years to come. If companies cannot earn money from consumers who won’t spend, their stock prices will languish. If you must own stocks, own companies that sells something people need (electricity, healthcare) as opposed to something people want (designer clothes) because we are in for a long slog.

Posted by Dan | Report as abusive

For whatever reason: if unknown, the famous video with
Peter Schiff and a lot of other financial experts forecasting, commenting and advising in 06 / 07, before
the crash, can be really recommended. The viewer can
instantly figure out things worked out, has perfect
knowledge in hindsight and knows much better now than
what the experts say. It is considered impressive, awesome.
http://www.youtube.com/watch?v=2I0QN-FYk pw

Posted by JF | Report as abusive

Paying off your mortgage is removing a tax-deductible expense, so it’s NOT like getting a 6% return.

Posted by VennData | Report as abusive

I would be curious to hear what your opinion of John Podhoretz’s claim that the efficient markets hypothesis is not dead is (link: http://www.commentarymagazine.com/blogs/ index.php/jpodhoretz/128291)

This argument appears dead wrong to me, if only because the efficient markets hypothesis assumes, in part, a normal distribution of asset returns. As per Taleb and Mandlebrot, among others, the recent volatility of the markets suggests that asset returns are emphatically NOT normally distributed.

Thoughts?

Posted by Dave | Report as abusive

I’m with you Dan and always have been.

Investing in strong (defensive) companies that make stuff and will continue to make stuff we need rather than want.

Posted by vk9141 | Report as abusive

Cramer was a Spartacist? He memorized Lenin’s “What is to be done?” He studied Trotsky?
Wow! You mean that he isn’t a one-dimensional babbler?

SOME of your mortgage interest is deducted from your taxes. Your mortgage is NOT a tax deduction. Paying off your mortgage is an excellent long term investment. If only because if you lose your job, you will be much less likely to lose your house…

Posted by Emma | Report as abusive

dave, i looked at that podhoretz piece yesterday and i said “it’s just a bunch of words that mean nothing,” which made sense, in that podhoretz is an idiot. it’s not even worth bothering to respond to him.

as to our host: he’s certainly right – you’ve got to know your risk appetite. i, for example, was a buyer in march because i felt the risk that everything was going to zero was overrated.

Posted by howard | Report as abusive

@ Dave
I’m pretty sure it assume normalized over the very very long run, which over the last 80 or so years hadn’t been unreasonable. Taleb mostly tried to say that efficient market promoters said that was the case over the short run. In spite of its flaws the EMH still provides us with some important reminders. First, most research you do yourself, has probably already been done and is probably already somewhat “priced in”. Second, strong good news gets processed very fast and prices respond quickly, so be careful before you jump in to make sure that the stock isn’t already valued to reflect that news. EMH isn’t all about always buying and never thinking, as many opponents to it have made it out to be.

Posted by Structured Products Guy | Report as abusive

If you’re going to be in the stock market, you should have some idea of the mechanics of it and where it is ‘at’ in context, at the moment. Don’t just blindly throw money into the market and ‘buy and hold’ as that ‘may’ not be the best strategy any more — if it ever was. Consider moving some profits into cash from time-to-time, after wild upswings. Yes, I’m talking market timing.

With that in mind, consider setting aside a portion of your stock money in cash — the % relevant to your age –, to be used for a more active lower-risk market timing strategy that involves buying in small increments after extreme selling — defining that can be tough — and then selling into strength on the — usually — inevitable ramps back up.

In this way, you can generate some extra profits and are forced to actually have an idea of how the markets behave which you should, if you are pumping money into it every month. The only time this will not increase your returns is during a mostly straight-up move but in that case, you will just make a bit less, you won’t be losing money. In side-ways or down markets, you will do better than just sitting there with all of your funds in stocks.

The difficulty with market timing though, is buying when it is most uncomfortable and then figuring out when to sell. Manage that risk by using this portion of your investing money in smallish increments after heavy selling. And no, I wouldn’t keep these shorter term funds in bonds, as those carry risk also, maybe especially now. Use a liquid money mart even though there is virtually no interest right now.

Posted by heywally | Report as abusive

VenDatta and Emma, quite right, it also depends what the tax effects of the new investment return would be and what the tax regime is in the particular environment. Also, cash losses might be so high, and the property value could dip to below the mortgage owing. Then one would be in trouble, as I suspect most people are right now.At the start of a mortgage, one usually pays interest until close to maturity, say on a mortgage of 20-30 years, the first 15 to 20 years is mostly interest repayments.

Posted by Casper | Report as abusive
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