There’s been no shortage of events lately to kick in people’s “I don’t trust the markets” instincts. You typically hear people uttering phrases like that in a bear market, although the QE-infused S&P 500 rally in the first half of 2013 provided a good excuse for investors and traders to be bearish in the middle of a strong bull uptrend.
The bond market correction that gained downside momentum in May was enough to make many swear off fixed income for good (or so they said). That attitude is reminiscent of sentiment in early 2009, when despondent equity investors bailed out of stocks, and, in many cases, were too discouraged to get back in. Ah, the perils of market timing.
A few years back, I overheard a conversation on a plane. Two guys were commiserating about the 2008-2009 bear market, and were rather proud that they got out, and hadn’t gotten back in. Keep in mind: This was late 2010 or early 2011. The S&P (most Americans’ proxy for “the market”) had rallied significantly from its March, 2009 bottom. Investors who fled entirely should not have been bragging to strangers on planes.
The recent Nasdaq trading halt sent a new wave of fear into investors, and gave columnists some fresh meat to toss at the lions. A Forbes.com headline proclaimed, “Nasdaq Flash Freeze Shows Markets Still Aren’t Safe.”
Really? How exactly did a software glitch on the Nasdaq show that investors should put their money under the mattress, or to cite the latest trendy and sophisticated-sounding anti-equity scheme, into “peer to peer lending.”
The author of the “markets aren’t safe” story wrote that the system is vulnerable to unexpected events. Sorry, but haven’t “unexpected events” always had a short-to-medium-term effect on markets? The S&P 500 recovered completely from the May, 2010 flash crash within four months, and was back to fresh highs within six months. Hardly catastrophic, except for those with a day-trading mentality. And even the day traders had ample opportunity to make up for losses in the ensuing months.
History is jam-packed with “unexpected events” that spurred a wave of anti-investing panic. But the long-term results are abundantly clear: By staying the course with a well-defined investment philosophy, and by allocating into a balanced, globally diversified portfolio, investors don’t have to let exogenous shocks wreck their goals, as determined by a sound financial plan.
And that’s the bottom line. A financial plan and its attendant investment philosophy will keep you from running from the room screaming when there is a market software glitch, or some piece of news that hits various indexes. (And for the record: The Nasdaq Composite is not “the market” any more than the MSCI Emerging Markets Value index is “the market.”) Investors are best served by keeping their money in varied asset classes. This allows them to take advantage of the randomness of returns which does, over time, lead to portfolio growth.
So retail investors who are clinging to a notion that the markets are not to be trusted, even as U.S. large caps are only a few weeks out from all-time highs, are buying into the breathless, hysterical headlines. Their investing years would be better spent developing a plan, and understanding the need to maintain diversification. Over time, this strategy has proven to deliver better portfolio returns than a panicked attempt at active trading, or, even worse, a jaded attempt to avoid stocks and bonds altogether.