Nervous times for investors

A trader on the New York Stock Exchange floor reacts Aug. 1 as the stock market closed out its worst week in two years.

Is the stock market going to fall, or continue the dramatic rise that began more than five years ago?


One of those things will surely happen. Probably both, given enough time, and worrying about which will happen when is about enough to drive an investor crazy.

The night of Aug. 1 was a Friday, at the end of a week in which the stock market declined enough to erase all the gains made in July and most of June. That night, I took a look at Marketwatch, a financial news website affiliated with The Wall Street Journal.

Here are the headlines from four columns that all appeared prominently that night:

"Stock trader who called three crashes sees 20% collapse"

"History says don't count on a big correction anytime soon"

"3 market warning signs predict 20% stock tumble"

"Ignore the bears and you could bank a 22% stock market gain"

So, whatever your opinion may be about the direction the market will take, you can surely find columnists and advisers who will support that view.

What I can say with confidence is that there's plenty of good research, and a lot of historic lessons, that suggests long-term investors would be well served by tuning out the noise.

For most households in the U.S., that's an easy thing to do, because more than half of them don't own any stocks at all - not even in retirement accounts or mutual funds.

Among those that do own stocks, the majority of folks own stocks only within retirement accounts, such as an IRA or 401k plan. That's long-term investing, and with long-term investing, what happens on Wall Street next week or next month is relatively unimportant compared to what happens over the next years and decades.

Of course, that doesn't prevent people from making bad choices. Countless studies have found that individual investors have a terrible habit of pulling their savings out of stocks after a market crash, such as in early 2009, and shifting money into stocks after big gains have been made, such as earlier this year.

Generally, those who stayed the course ended up better off. It's tempting to try and get in and out of investments at just the right time. Anyone who sold out of the stock market in 2007 and jumped back in around March 2009 would have looked like a genius - a wealthy genius.

If timing the market was easy, professional fund managers would beat the average gains of the broad stock market. They don't.

One thing that individuals can reasonably try to time, however, is their retirement. And one thing individual investors can control is their exposure to risk.

Someone close to retirement has a lot more to lose from a 20 percent drop in the stock market than a person who is 30 years from retirement. Markets tend to recover, but it can take years. People can't expect to time the market, but they can adjust their exposure to risky investments as they near retirement and their time-frame to recover any losses gets shorter.

It's important to remember that a 20 percent loss is larger than a 20 percent gain. If an investment falls by 20 percent - for example, a stock worth $100 that falls to $80 - that investment would need to then gain 25 percent to break even. Likewise, a 25 percent gain would be erased by a 20 percent loss.

For people with a long investment time-frame, dollar-cost-averaging smooths out the bumps in the market. People who make regular investments in retirement accounts through payroll deductions are already doing this.

Basically, if a person buys "X" dollars worth of an investment every week or two, those dollars will buy more of that investment when the price is low, and less when the price is high. So, as stocks and bonds rise and fall, steady investing every payday averages out the costs and captures the long-term trend, which historically is up.

The stock market has certainly soared, more than doubled, since early 2009, and isn't far from an all-time high. If you're a long-term investor, it makes sense to re-evaluate your goals and your tolerance for risk, but don't let the day-to-day headlines keep you up at night.

Contact David Slade at 937-5552.