Avoiding the Market Is Not a Sane Strategy

by Will Ashworth | October 11, 2012 7:00 am

The National Center for Policy Analysis came out with an insightful report Sept. 11 titled How Are Baby Boomers Spending Their Money?[1] The study examined the spending habits of 45- to 64-year-olds in 2010 compared to those in 1990. The main finding: People today are spending their disposable income on different categories of goods and services than 20 years earlier.

It also found that boomers weren’t putting aside anywhere near 10% of their income for retirement. Compounding the problem is a phobia of the markets, not just by boomers, but all small investors. Risk aversion is costing many people a comfortable retirement. Let’s look at why we continue to make so many poor investment decisions.

One of the biggest myths in financial circles is the oft-mentioned story that half the investors in the Fidelity Magellan fund over the 14 years that Peter Lynch ran it lost money. Lynch delivered annual returns near 30% over his tenure, yet investors lost money, the story goes, because they hopped in and out of the markets.

It’s a wonderful tale, but one that’s not true. However, the sentiment is. Retail investors are notoriously restless, holding the average equity mutual fund for just 3.3 years. It sounds like a lot, but consider that the current bull market started in March 2009 is going on four years with a reasonably good chance that it will continue well into 2013.

But investors, scared by severe market pullbacks like the most recent in 2008, have given up on buy-and-hold investing.

Big mistake.

The S&P 500 has more than doubled since the market lows in early 2009. A $10,000 investment in the SPDR S&P 500 (NYSEARCA:SPY[2]) on March 9, 2009, (the ultimate low) is worth $22,795 as of Oct. 9. The problem: Investors have taken more than $500 billion out of U.S. stocks since the lows, completely missing out on the bull market.

As the S&P 500 gained almost 10% over this summer, investors withdrew $40 billion from U.S. stocks. It’s a classic case of death by a thousand paper cuts.

Experts suggest boomers are converting to fixed-income investments now while they still have some money in their accounts. I guess it’s understandable given two market corrections in the past decade. But low interest rates have forced them to make speculative high-yield bond investments. As a result, boomers are heaping poor investment choices on top of terrible market timing, creating a perfect recipe for portfolio disintegration.

In my experience, the longer you’re out of the market, the harder it is to jump back in. The past decade has seen equity ownership (stocks, mutual funds and ETFs) drop from 53% in 2001 to 46.4% in 2011. It’s probably never coming back. A significant chunk of the American population has missed out on restoring their net worth prior to the recession.

For the wealthy, that’s not a big deal. However, for the rest of us, it’s extremely damaging. Lori Heinel, chief investment strategist at Oppenheimer Funds says this about the situation: “…Some of these investors may just want to preserve capital. They don’t necessarily have to see it grow. I’m more concerned about the average investor with a 401(k) balance that’s less than $100,000.”

There’s a lot of folks aged 55 to 64, according to the Employee Benefit Research Institute, which suggests the median 401(k) balance in that age group is $58,000. Heaven help this group if housing prices don’t recover more quickly in the decade ahead.

The American Association of Individual Investors reported Sept, 27 that just 36.1% of investors believe stocks will rise over the next six months. More important, investor sentiment has registered below the historical average of 39% in 25 of the last 26 weeks.

Care to guess what’s most significant about this data? A majority of investors have historically been bearish or neutral about the short-term direction of the market. The AAII has kept this data since July 1987. Still, if you bought $10,000 in Apple (NASDAQ:AAPL[3]) stock back then and held today, you’d have $658,000 now.

The moral of the story: Always be contrarian to the majority sentiment. You’ll win almost every time.

Risk aversion has become the norm in America. Investors avoid equities, banks avoid lending and employers avoid hiring. Is it any wonder the economy is stuck in a rut when so many people are afraid to step off the curb. The current so-called “retirement crisis” is in many ways self-inflicted. It doesn’t have to be that way. Risk is not a four-letter word.

As of this writing, Will Ashworth did not own a position in any of the stocks named here. 

  1. How Are Baby Boomers Spending Their Money?: http://www.ncpa.org/pub/st341
  2. SPY: http://studio-5.financialcontent.com/investplace/quote?Symbol=SPY
  3. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL

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