Why do we want stocks to go up?

February 23, 2011

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Comment of the day comes from TFF:

When asset prices go up, you are poorer.

When asset prices go down, you are richer.

That equation holds true as long as you are in the accumulation phase of your life. It reverses in retirement, and is perhaps ambiguous for somebody nearing retirement, but for somebody in their 20s, 30s, and 40s, it is undeniably true.

As someone who’s saving for retirement, this is clearly true. My preference is for assets in general, and stocks in particular, to be as low as possible for as long as possible, so that I can accumulate as many of them as I can before they go up and as few as necessary after they’ve become expensive.

But here’s the weird thing: most of the people cheering for the stock market to go up are in the accumulation phase of their careers, not the spending phase. They’re still putting money into retirement funds, and they aren’t intending on spending it for decades. So why are they so happy when stocks go up, and sad when stocks go down? Shouldn’t it be the other way around?

One good reason is that if you require a certain annualized rate of return over the years that you save for retirement, then every year that return is low only serves to push the necessary future return further and further out of reach.

A less good reason is the internalization of the false promise of compound interest — the idea that you want your money to be compounding from day one. In reality, yields go up when prices go down, and you still want to be able to compound at high yields, when prices are low, rather than at low yields, when prices have risen. If you can save for decades at a steady real yield of 5% with prices going nowhere, you’ll accumulate much more money than if you start saving at 5% and then rates quickly drop to 1%. Even after accounting for the capital gain on the first bonds you bought.

The main reason, however, is simply psychological. If asset prices go up, that means people with assets are richer, and have made money in the markets. If you’re rich and you’ve made money, that makes you happy. Even if over the long term you’d be better off if you were able to continue buying bargains.


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