Saturday, October 3, 2009

Why It Feels So Rough in the Stock Markets

If investing in stocks feels like you're riding through white water, you're not imagining things. It is rough in the market. Let's look at the data.

The 1920s were a period of secular, or long term, market rise. Then, the 1929 market crash knocked the market for such a loop that it did not recover on an inflation adjusted basis until 1953. Then the market enjoyed a secular rise until the end of 1972. However, with the malaise of the 1970s setting in, the market fell and did not recover on an inflation adjusted basis until 1991. Between 1991 and early 2000, the market rose on a long term basis. However, after peaking in March and April 2000, the market has never fully recovered. Currently, adjusted for inflation, the market is at 1997 levels; it's gone nowhere for the past 12 years.

In all, since 1920, the stock market has, on a long term basis, risen a total of 37 years. It has been in a losing position (compared to the preceding peak and adjusted for inflation) for a total of 50 years. No wonder stock market investing makes a lot of people seasick.

Of course, the good years saw gains that greatly exceeded the losses in seasick years. Overall, since 1920, the market has been a very good investment on a long term basis. But, as John Kenneth Galbraith put it, in the long term we're all dead. If your time horizon is about 15 or 20 years, you should be cautious with stocks. Some equity exposure is prudent, because there will be mid and short term rallies even during long term downturns. But you should use bonds or comparable investments to stabilize the value of your portfolio. If your time horizon is short, like a few years or less, it's best to step back from stocks. You may miss out on some gains. But you don't want to lose your child's college tuition money, the down payment on your house, or the funds for Mom or Dad's assisted living expenses.

Even though diversification isn't a bulletproof investment strategy, it still makes sense for many people on a long term basis. If you're taking too many painkillers because of your stock investments, reduce your equity exposure. Put it all in bank CDs if that let's you sleep. Keep your portfolio simple. (See Whatever you do, don't stop saving. People who don't prepare for the future won't have much of one.

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