Friday, June 05, 2009

The Reward of Diligent Investing

This bear market has been brutal, but those of us who have continued to invest through the worst of the market have been seeing some pretty impressive gains. I am glad to report that we fall into this category.

Yesterday I did my usual Quicken review of our portfolio and was happy do discover that my 401K is now at break even point. I joined my company in March 2008 and joined the 401K plan in May (I still maxed out my contributions for the year, don't worry). While my early stock investments in the plan are still down about thirty percent, the positions that have been purchased since November are all now above water. The combined result is break even.

I have written repeatedly about the fact that we have been putting more money into the stock market on a monthly basis throughout the crisis. My review of the portfolio revealed, for example, that a position we purchased in Vanguard's Total International Stock Index fund in March is now 38% above it's purchase price. Naturally, our portfolio as a whole is still very much down and will likely take years to recover, however the stock positions that we have been buying through the worst of the downturn are helping our overall portfolio to recover much faster.

Incidentally, I have now stopped our monthly mutual fund purchases (with the exception of my 401K contributions). For one, I feel that the stock market has been rising too quickly over the past couple of months. I don't think it's as huge a bargain as it was just a few months ago. I do believe that we are going into a recovery and that the stock market rally is for real, however I think that the current rally may be a bit over done in the short term. If this sounds a bit like market timing, you may be on to something, but the current aggressive skywards move makes me really nervous and I am going with my gut. I prefer to buy stocks on the way down... Another reason for my halting our new purchases is that I would like to keep a larger cash position on hand. I think we may be getting to the point where buying a house is something we would want to entertain, and if that is the case, I would like to have the cash to move forward while limiting our dependence on the short term performance of the stock market.

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Rob Bennett said...

If this sounds a bit like market timing, you may be on to something

Stop apologizing!

(I'm just joking around, Shadox.)


Shadox said...

I can't help myself! Short term timing - my head tells me "no", my guts tell me "what's the big deal you bastard?"

Anonymous said...

OK, here's my question for you. Say the market continues to climb over the next three, six, nine months or longer. Is there some point where you say to yourself, "I guess I should get back in." ?

The problem with the timing you are doing is that it's only obvious when to make the next move if your first move was correct.

This type of thinking has caused me to miss many great investments -- that is, thinking they were already too high to bother investing and then watch them run up another 100% or more over the following years.

Also, if you or Rob could explain to me how you engage in "long term timing" without it actually being "short term timing", I'd really appreciate it. As far as I can tell, even Rob's suggestions require you to implement the changes at a particular criteria point which could be met just for one day or for years. How do you pick the day?

Rob Bennett said...

How do you pick the day?

You're asking a good question, Ren. I think it's one that trips up a lot of people.

The answer is -- with long-term timing, picking the right day to make your move doesn't matter.

We were at insanely high stock prices from January 1995 all the way through August of 2008. If you had lowered your stock allocation in January 1995, you would have been helping yourself. If you had lowered your stock allocation in January 1996, you would have been helping yourself. It's the same with June 1999 and April 2003 and February 2007. The day you make the move doesn't matter.

Valuation-Informed Indexers don't ever try to pick tops and bottoms. They understand that this is a doomed effort and they want nothing to do with it.

What they do is examine value propositions and set their stock allocations accordingly. It is undeniable that stocks offer a far stronger long-term value proposition today than they did at any time from 1995 through August 2008. So it does not make sense for a long-term investor not to have a higher stock allocation today.

Our understanding of investing has improved over time. In the pre-Bogle days, just about everyone had a short-term focus. Bogle started a revolution. He was the first major figure to urge a long-term focus. Shifting from a short-term focus to a long-term focus stands everything we once thought we knew about investing on its head.

Bogle just happened to make a mistake. It happens. Few before him had employed a long-term focus, so it was hard to figure out all the details of what that entailed. Now we (at least some of us) know. Being a long-term investor means focusing on value propositions and getting away from the focus on short-term ups and downs that consumes even the Passive Investors today (they talk it down, but they remain consumed by this stuff all the same).

It doesn't matter what day you choose to engage in long-term timing. All that matters is that you always be sure to do it. You only need to make one change every 10 years or so on average. But making that one change lets you retire many years sooner.


Rob Bennett said...

even Rob's suggestions require you to implement the changes at a particular criteria point which could be met just for one day or for years.

I read the thread again and thought that perhaps I should try to focus in on this particular point.

Say that you are following a Valuation-Informed Indexing strategy in which you intend to go with a 60 percent stock allocation at moderate valuations (like those that apply today) and a 30 percent stock allocation at high valuations (like those that applied before the crash) and a 90 percent stock allocation at low valuations (like those that applied in the late 1970s and early 1980s and that we will probably be seeing again a few years from now).

Say that you define "low valuations" as a P/E10 level below 10. And say that two years from now we go to a P/E10 level below 10 for two months and then jump back above 10. Did you make a mistake if you failed to increase your allocation from 60 percent to 90 percent during that two-month time period?


It doesn't matter.

You can check this by running some tests on the Investor's Scenario Surfer (a calculator at my site).

Stock prices are set in the short-term by investor emotion (it is only in the long term that the economic realities set stock prices). This is why stock prices play out in cycles. We go from extremely low prices to moderate prices to extremely high prices and then back. This general pattern ALWAYS repeats. This is because we go through the same emotional shifts over and over again. Whenever we permit prices to get too high, we insure that in coming days they are going to go extremely low because the drop from high to moderate (which is required by the economic realities) is going to cause a mass freak-out. Emotional (and price) extremes in one direction beget emotional (and price) extremes in the other direction.

We are in all likelihood going to see price levels FAR lower than those that apply today within the next five years or so. Investors have not yet psychologically accepted how much they have destroyed themselves. It is going to take years for that reality to "take." When it does, the P/E10 level will probably drop to 7 or 8. That's a 50 percent drop from where we are today.

(Part Two Follows)

Rob Bennett said...

If you accept that much, there's a temptation to say "Well, I just won't put anything at all into stocks until I see the drop to 7 or 8." No! That's a MISTAKE!

The P/E10 level will PROBABLY drop much lower. But this is not certain. There is perhaps a 30 percent chance that we will stabilize at moderate price levels and never drop that much lower. If that bet comes in, you don't want to be going with a zero stock allocation for all those years. That will pull your return way down because during years when the P/E10 level is stable, stocks are providing an annual real return in excess of 6 percent. That's far better than what you can get from alternative investment classes.

Investing is a game of probabilities. The probabilities say that we are going much lower. But you want to be covered regardless of which of the most likely scenarios comes through. Stocks are at moderate prices today, so you want to be at a moderate allocation. That way you do well in the unlikely event that prices stabilize and you also do well in the more likely even that prices drop much lower.

It's important to understand that any losses you suffer from price drops today are TEMPORARY losses. This is in contrast to the PERMANENT losses suffered by those invested heavily in stocks before the crash. When prices are fair, drops are sure to be made up within 10 years or so (because the market forces prices back to fair value in the long term). When prices are insanely high, the losses are never recovered because there was never any reality to those prices in the first place.

So --

If investor emotions are going to pull prices far lower in time, they are not going to do so only for a month or two or three. If we are going much lower, we will be at the much lower prices for at least a year, probably much longer. We will be at those prices long enough for investor emotions to accept the realities. That never happens in weeks or months. It always takes years.

You don't have to worry about making allocation changes within any small window of opportunity. It just doesn't matter. If you lower your allocation when the P/E10 goes below 10 and then it goes above that, just stick with the lower stock allocation and it will go back down below 10 again in time anyhow. If you fail to make the shift on the first drop below 10, just wait until the next one. It might take a year or two. It doesn't matter. Always focus on the long term and tune out the short-term noise.

Just like Bogle says! (That's a joke.)


CashAholic said...

I haven't invested any money in the market this. I still have all my holdings from 2008, and I have seen an slight increase. I'm still down overall.

Finance Phi said...

A friend of mine is determined to make it big in bio/pharma stocks. He's literally putting all his eggs into one basket. I kept telling him about the dangers of not diversifying, etc.

Yesterday he let me know that he's now a millionaire off a penny stock. I'm confused.