Chapter 5
Investing in a raging bull (or bear)
market
As of January 2015, the S&P 500 stood at 2,059, up sharply from its March 2009 low around 677. This is the very definition of a raging bull market.
Whether you are considering investing a new chunk of cash that has come your way, or thinking about selling and sitting on the sidelines for a while, it is times like these that test your core investing principles and beliefs.
Here are some of mine:
It is simply not possible to time the market, regardless of all the heavily credentialed gurus on CNBC and the like who claim they can.
The market is the most powerful wealth-building tool of all time.
The market always goes up and it is always a wild and rocky ride along the way.
Since we can’t predict these swings, we need to toughen up mentally and ride them out.
I want my money working as hard as possible, as soon as possible.
For novice investors, it is very difficult not to look at the past market swings and think, “If only!” If only I had sold when it was up. If only I had bought when it was down. But wishing doesn’t make this possible.
Since I launched www.jlcollinsnh.com in 2011, the market has been on one of its great bull runs, coming off one of its great bear crashes. On a fairly regular basis, I get questions and concerns like these:
“Is NOW a good time to invest, right before a possible stock market crash?”
“...a lot of people seem to think a stock market crash is just around the corner.”
“I fear I’m entering at the wrong time.”
“I’m afraid I’m investing right before a stock market crash...”
“My fear had held me off for months, but I feel because I’m holding off I’m losing out.”
“I just want to get off to a good start, not a bad one.”
“Maybe I should wait until after the crash so I don’t lose a chunk of money.”
“Should I just hold off until after a crash so I can make the most of my money?”
“I’m just so fearful since I’m so new to this...”
If the market happened to be plunging into one of its periodic bear cycles these questions, and the psychology, would be much the same:
“Should I wait until the market has bottomed out and then invest?”
This is all about fear and greed, the two major emotions that drive investors.
Fear is perfectly understandable. Nobody wants to lose money. But until you master it, such fear will be deadly to your wealth. It will prevent you from investing. Once you are invested, it will cause you to flee in panic for the exits every time the market drops. And drop—repeatedly on its relentless march upward—it will. The curse of fear is that it will drive you to panic and sell when you should be holding. The market is volatile.
Crashes, pullbacks and corrections are all absolutely normal. None of them are the end of the world, and none are even the end of the market’s relentless rise. They are all, each and every one, expected parts of the process.
Inevitably, as we’ll discuss in Part II, there is a major market crash coming, and another after that. Over the decades you’ll be investing, countless smaller corrections and pullbacks will occur as well. Learning to live with this reality is critical to successful investing over the long term.
And successful investing is by definition long term. Any investing done short term is by definition speculation.
Therefore, if we know a crash is coming, why not wait to invest? Or, if currently invested why not sell, wait till the fall and then go back in? The answer is simply because we don’t know when the crash will occur or end.
Nobody does.
Don’t believe me? Think you can? Test yourself here: http://qz.com/487013 You may have heard that a lot of people think a stock market crash is just around the corner. That’s certainly true, but there are also lots of people who say we are just at the beginning of this boom and we will never see the S&P this low again. Every day, heavily credentialed experts are predicting a market crash. At the same time, equally credentialed experts are predicting a boom. Who’s right? Beats me. Both are predicting the future and nobody can do that reliably.
So, why all the predictions? Simply because booms and busts are exciting! Get it right and your Wall Street/television reputation is made!
Predicting them equals ratings, especially if the predictions are extreme.
Predict the Dow soaring to 25,000 or crashing to 5,000 and people perk up.
There is big money to be made doing this, for the gurus and cable TV shows anyway.
For serious investors, however, all of this is useless and distracting noise. Worse, if you pay attention to it, it is positively dangerous to your wealth. And your sanity.
The Dow Jones Industrial Average 1900 – 2012 Credit: www.stockcharts.com
History can help, but only on the broadest of scales. You see it in the chart above. The stock market always goes up. There are powerful reasons why. I can say—with almost absolute certainty—that 20 years from now the market will be higher than it is today. I’d even say with a high degree of confidence that 10 years out it will also be higher. 120 years of market history bears this out.
However, this says nothing as to what the next few days, weeks, months or even years will bring.
Here’s the problem. There is simply no way to know where in time we are.
Take another look at that chart. Could we be at a moment similar to January 2000 when the market peaked and went on to lose almost half of it’s value? Or in July of 2007 when it did the same? Sure, it is easy to see that pattern in retrospect.
Or could that pattern have run its course, and now we find ourselves in a period more like the time the market passed 1,000 or 2,000 or 3,000 or 4,000 or 5,000? Where each level was left in the dust, never to be seen again? Beats me.
What we do know is that each of these milestones was surpassed at times like today when people were every bit as convinced that the market was too high and ready for a crash.
With that said, let’s assume we do know that right now, at 2,102, the S&P 500 is at a peak and about to crash. Maybe a magic genie has told us so.
Clearly we’ll sell (or at least not buy). But now what? We want the gains only the market can deliver. So we want back in at some point. But when?
Is this a 10% pullback? If so, we’ll want to buy at 1,892 or so.
What if it’s a 20% decline, the official definition of a bear market? Then we don’t want to buy until around 1,682.
But what if we do that and it turns out this is a crash!! Damn! In that case, we should have waited until it dropped all the way down to 1,200 or so. Where’s that pesky genie when we really need him?
The point is that to play this market timing game well even once, you need to be right twice: First you need to call the high. Then you need to call the low. And you must be able to do this repeatedly. The world is filled with sad investors who got the first right and then sat on the sidelines while the market recovered and marched right on past its old high.
Market timing is an un-winnable game over time. How can I be so sure?
Simple:
The person who could reliably do this would be far richer than Warren Buffett, and twice as lionized.
Nothing, and I mean nothing, would be more profitable than this ability.
That’s what makes it so seductive. That’s why gurus constantly claim they can do it, even if only a tiny bit. Nobody can. Not really. Not in any consistently useful way. Believing in Santa Claus is more profitable.
Breeding unicorns is more likely.
But I don’t care that this timing can’t be done. Using the following illustration, let’s demonstrate what I’d care about if I were you.
Let’s assume you are 30 years old. You have some 60 or 70 investing years ahead. I’d look at that chart and note that some 60 years ago the Dow was trading at ~250. By January 2015 it was around 17,823. That’s through 60 years of turmoil and financial disasters, just like the ones sure to come over the next 60 years.
Or just consider the last 20 years and the history of the S&P 500. In January 1995 it was around 500. By January 2015 it reached 2,059. And that includes 2000-2009, one of the all-time worst stretches in market history capped off by a crash second only to the Great Depression.
It is in this where the real magic is found. The stock market’s wealth- building power over time is nothing short of breathtaking.
But so is the ride along the way. Whether you invest today or sometime in the future, I guarantee your wealth will be cut in half more than once over those 60 years. You’ll suffer many other setbacks as well. It is never fun—but it is the process—and the price you and everybody else must pay to enjoy the benefits.
Thus the question is not “Should I invest in stocks now?” Rather it is “Should you invest in stocks at all?”
Until you can come to terms with the harsh facts above, the answer is no.
Until you can be absolutely certain that you can watch your wealth get cut in half and still stay the course, the answer is no. Until you are comfortable with the risks that come with the rewards you seek, the answer is no.
In the end, only you can decide.
Fortunately, investing doesn’t have to be an all or nothing proposition. If you are willing to give up some performance, there are ways to smooth out the ride a bit. It is done with asset allocation, which we’ll discuss in Chapter 14.
Note: In referencing the market’s performance in this chapter, you may have noticed I jump between using the Dow and the S&P as the indexes. I prefer the S&P because it is broader and therefore a bit more precise. But the Dow goes back further in history and is more useful (and available) for the long view. If you overlay their charts over time, they track together with remarkable consistency, making them, for our purposes, indistinguishable.