REM, Pascals Wager and The Stock Market

"Its The End Of The World As We Know It, And I Feel Fine"
The classic REM tune has been resonating in my head over the last month.  I do feel fine. Well, fairly fine, and this is why:
As I have been discussing the recent market volatility, I have stated the idea that if the stock market crashes and never returns above current levels, or goes to zero, then that would mean our capitalist economy has collapsed and therefore our dollars and "safe" US Treasury securities would likely be worth nothing.  It would be the end of the world as we know it. 


So, like the French philosopher, Pascal, who wagered that one should believe in God, because to believe means eternal paradise and if God doesn't exist then nothing is lost, I am wagering on capital (stock) markets to continue to provide good risk adjusted returns. If they don't, it wont matter where I had my money stashed.  I am wagering on the stock market over the long term and I know that if I get out of stocks now I will  lock in my losses and likely miss the increase in prices that has always occurred with stocks after a correction. And, if it is the end of the world as we know it, then nothing is gained and all I will have is meaningless losses.


Therefore, I  feel fine. Either I will be ok or it wont really matter. I dont worry about the day to day stock market craziness. I know that will happen. I don't invest in stocks to make short term gains. I hold a well diversified portfolio, that as long as capitalism survives, should provide me with a nice risk adjusted return - I hope somewhere between 6% and 10% over the next 30 years. I have 60% of my retirement in the stock market. I am 45 years old,  I wont need that portion of my portfolio for 30 years and the stock market has always been the best investment over that length time.


If you continue to read through the lyrics below, you will read the last line: "its time I had some time alone"  By taking the leap of faith and developing a well diversified portfolio, rebalancing it and letting it ride you will capture a the long term returns of the global capital markets and you will have your time to be alone and not worry about the markets and whether to buy and sell or shift to a new sector. 
 As for me, I am going to hit send, turn off CNBC and go for a run and have time to myself.

"That's great, it starts with an earthquake, birds and snakes, an aeroplane -
Lenny Bruce is not afraid. Eye of a hurricane, listen to yourself churn -
world serves its own needs, regardless of your own needs. Feed it up a knock,
speed, grunt no, strength no. Ladder structure clatter with fear of height,
down height. Wire in a fire, represent the seven games in a government for
hire and a combat site. Left her, wasn't coming in a hurry with the furies
breathing down your neck. Team by team reporters baffled, trump, tethered
crop. Look at that low plane! Fine then. Uh oh, overflow, population,
common group, but it'll do. Save yourself, serve yourself. World serves its
own needs, listen to your heart bleed. Tell me with the rapture and the
reverent in the right - right. You vitriolic, patriotic, slam, fight, bright
light, feeling pretty psyched.

It's the end of the world as we know it.
It's the end of the world as we know it.
It's the end of the world as we know it and I feel fine.

Six o'clock - TV hour. Don't get caught in foreign tower. Slash and burn,
return, listen to yourself churn. Lock him in uniform and book burning,
blood letting. Every motive escalate. Automotive incinerate. Light a candle,
light a motive. Step down, step down. Watch a heel crush, crush. Uh oh,
this means no fear - cavalier. Renegade and steer clear! A tournament,
a tournament, a tournament of lies. Offer me solutions, offer me alternatives
and I decline.

It's the end of the world as we know it.
It's the end of the world as we know it.
It's the end of the world as we know it and I feel fine.

The other night I tripped a nice continental drift divide. Mount St. Edelite.
Leonard Bernstein. Leonid Breshnev, Lenny Bruce and Lester Bangs.
Birthday party, cheesecake, jelly bean, boom! You symbiotic, patriotic,
slam, but neck, right? Right.

It's the end of the world as we know it.
It's the end of the world as we know it.
It's the end of the world as we know it and I feel fine...fine...

(It's time I had some time alone)"

What Stocks Typically Do After a 20% Correction

The above chart was put together by Citigroup and looks at stock returns following 20% market corrections when corporate earnings remain stable. Returns have averaged 20% the following 12 months.
I am not predicting a coming market rise or advocating a blind faith in stocks. I show this and other data in my blogs to emphasis that the stock market is very volatile in the short run, but has historically given better long term returns than corporate and government bonds and commodities like gold.
If one panics today, there is a good chance that they will miss the subsequent rise in prices.
The stock market is high risk and for long term investment. One is rewarded for time and the stomach to ride out the market swings.

A Chart Summarizing Market Volatility

The chart below shows the return for all the rolling 1, 3, 5, 10, 15, and 20 year periods between 1926 and 2008. 

1 year average returns have fluctuated between almost -50% and almost +50%. But there has not been a 15 year period or longer that the stock market has had a negative return.

Safe investing in the stock market requires a long time horizon. For those who have the time and patience the stock market has always given investors a positive return.

Finally: If you think you can time the market and escape the volatility, read the following from Charles Ellis's Winning the Loser's Game: 

    “Market timing is a "wicked" idea. Don't try it-ever. Using the S & P 500 average returns, the story is told quickly and clearly: All the total returns on stocks in the past 75 years were achieved in the best 60 months (less than 7 percent of those 800 months-over those long years). Imagine the profits if we could know which months! But we can- not and will not. What we do know is both simple and valuable: If we missed those few and fabulous 60 best months we would have missed almost all the total returns accumulated over two full generations. A recent study by T. Rowe Price shows that a $1 investment in the S & P 500 that missed the 90 best trading days in the 10 years from June 30, 1989, to June 30, 1999, would have lost money (22 cents) and would have made only 30 cents if it missed the best 60 days-but would have made $ 5.59 by staying fully invested. “

Charles D. Ellis, John J. Brennan. Winning the Loser's Game: Timeless Strategies for Successful Investing. (McGraw-Hill, 2002). Page 14.

Asset allocation, not stock-picking, is key to solid returns

Asset allocation, not stock-picking, is key to solid returns

More great advice.

Burton Malkiel: Don't Panic About the Stock Market - WSJ.com

Burton Malkiel: Don't Panic About the Stock Market - WSJ.com

From last weeks WSJ: Malkiel is one of the fathers of using index funds as an investors most efficient way to get exposure to the stock market. His book: "A Random Walk Down Wall Street" is the book I recommend as a place to start an understanding of investing in stocks.

I remind investors: Your money in the stock market is money that you will not need to touch for at least 10 years. Trying to predict the short term stock market fluctuations is a dangerous game. But over longer periods, those who stay the course will generally do well.

Market Timing: From "The Social Animal" by David Brooks

While on vacation I have been reading "The Social Animal" by NY Time columnist David Brooks. The book follows the social development of two individuals . One from an upper middle-class background and the other from a culturally diverse urban background.

In Chapter 10, on intelligence, he has an anecdote on why intelligent people sometimes are not good investors:

"intelligent people have excessive faith in their intelligence, from 1998 through 2001 the First Hand Tech Value mutual fund returned 16%, the average investor in the fund lost 31.6%. Why? Because the geniuses thought they could get in and out of the market at the right moments and missed the important up days and caught the devastating down days."

This point has been proven in many other longer tern studies such as Dalbars annual study and others that show how missing the best 10 up days over a period of 10 years can be devastating to a stock portfolio.

Emphasizing this lesson for today: One should only be in the market if they do not need that money for at least 10 years. Therefore, I do not know, nor does anyone else when the market will change. But we do know that timing the market does not work, stock markets are hugely volitile at times, but over long periods they offer very good returns for those that stay the course. This crazy, scary volatility is the price one pays for the highr returns the stock market has historically delivered.

The Canadian Couch Potato defending passive investing. Especially relevant in a turbulent market .

The following blog link does a good job of defending passive investing - especially during these volatile times.
Remember passive investing is about building a portfolio that meets your risk tolerances and time horizons and then uses index funds as the investments in the portfolio. And, very importantly, staying with the plan unless time horizons or risk tolerances change.

http://canadiancouchpotato.com/2011/08/02/why-passive-investors-arent-really-lazy/