Never Count Out Stocks

02/06/2012 9:19 am EST

Focus: MONEY MANAGEMENT

Terry Savage

Author, The Savage Truth on Money

The recent rebound in equities rewarded investors who stuck with plans they could stick with, a valuable lesson for any new investor, writes MoneyShow.com personal finance expert Terry Savage.

It happened so quietly, and under the cover of volatility, that you might have missed it. But last week, the stock market reached its highest level since May 2008.

The Dow Jones Industrial Average closed at its highest level since beforethe September 2008 Lehman Brothers collapse—which triggered all sorts of mayhem and pushed the index down to the 6,700 level by the following March. The new DJIA high happened under cover of all the headlines about Europe’s financial woes, and the worries about global financial disaster.

Even more deeply “undercover”, the Nasdaq Composite index, spurred by a surge in technology stocks, jumped to its highest close since December 2000!

And all this happened while most ordinary investors were still scared to invest. In fact, $20 billion flowed out of domestic equity funds in December 2011—thereby missing the nearly 4% market gains in January.

In fact, total inflows to all kinds of mutual funds dropped by $20 billion last year, as scared Americans decided to hoard cash in the banking system, while deposit accounts expanded by about $2 trillion in the past few years.

And now we’re at new highs. If you stuck with your plan of regular investing in your 401(k) or IRA, despite the volatility, you would have accumulated quite a portfolio—at much lower costs than today’s headlines.

It was tough to stick to the plan. That’s the point of discipline. As I’ve noted in earlier columns, in 2011 the Dow Jones Industrial Average gained 608 points. But if you added up all the closing point changes (up 300 points one day, down 150 the next, etc.), the index traversed a total of 28,032 points on a closing basis during the year.

That was enough to give any investor heartburn and indigestion on a daily basis. But those who were able to keep their emotions in check over the past few years have been well rewarded.

Where Do We Go from Here?
Now what? That’s the question on the mind of all investors, whether they are market participants or wishing they were. And it’s no easier to make that call now than it was back in March 2009, when this column begged stock investors to merely stick to their plan of regular investing.

Certainly, there will be more volatility. And equally certainly, there will be announcements of fund managers who have “beat” the market—and of market timers who have called the turns in between the ups and downs of the past few years. But it’s as tough to be right about which market technician to follow, or which mutual fund to choose, as it is to call the market itself.

Every year or so, a different group of stocks is “in fashion.” But fashion can change quickly. Last year’s most popular stocks can move to the bottom of the list more quickly than your favorite NFL football team.

Mutual funds that loaded up on financial stocks in 2011 suffered huge losses, but the banking group has been a winner so far this year. Meanwhile, last year’s list of winners was topped by utilities—a much ignored, stodgy group in previous years, but one that performed well in 2011 because of the higher and more secure dividend yields that utility stocks offer.

“Beating” the Market
It’s easy to move from understanding the importance of being in the market, to trying to “beat” the market by picking the best mutual fund or stock group. That’s where most ordinary investors go wrong, because the challenge of doing better than the market is so daunting.

Yes, the pros who manage the funds are paid for beating their benchmark indexes. But for ordinary investors trying to build assets for retirement, that’s quibbling around the edges.

Your most important decision is not “which” stock, stock group, or mutual fund. It’s just the decision about being invested in the market. In the long run, that’s the decision that will have most impact on your financial future.

And please don’t hide behind the oft-heard “excuse” that the market is rigged to favor the professional investor. Yes, the headlines about insider trading have been disconcerting. Even worse, Congress is finding it tough to ban its own members from “legal” insider trading!

But for the vast majority of us, the long-term gains potential of the stock market is not driven by any inside knowledge. It is driven by the long-term growth potential of the American economy.

And if it makes you feel better, even the professional money managers have a tough time “beating” the market. According to Morningstar, in 2011 just 23% of equity mutual fund managers beat their relative benchmark—the worst performance in more than a decade.

Just Do It!
Yes, it’s tough to watch your hard-earned money go into the risk pool of the stock market. Especially when you saw money melt away in past market declines.

That’s why you have to decide—based on your situation in life and your personal risk tolerance —how much of your money belongs in the stock market. But the time to make that allocation decision is not in the heat of passion when the market is making new highs, or lows. That’s when fear and greed override common sense.

Since, it’s almost impossible for most investors to control those emotions, the best course of action is to make a plan that you can carry out over the long run. Then stick to the plan.

You can start any time—even now. And that’s The Savage Truth.