You have heard it said time and time again: There are no sure things in investing.  This year you cannot even count on death and (estate) taxes going together.  But, in general, you cannot win a race looking backwards.  Past returns are, well, in the past. 

Background

There are several reasons why gold is bought.  There is an industrial demand for it, and manufacturers use it to make jewelry.  The recent high interest and demand in gold is because it is perceived as a better store of value and the ultimate insurance for really bad economic times, as in a depression or hyperinflation.  Furthermore, some investors now consider gold as an asset that can help diversify a portfolio comprised of stocks, bonds, and real estate.  (In my opinion, the addition of an asset class usually happens after a sharp rise in its price.)

Looking at not just the recent past but putting gold prices into the historical context of the last 30 years tells a much less favorable story.

The last time we witnessed such high interest in gold was back in November 1979, when the price of gold rose from $400 an ounce to $850 by mid-January 1980.  Investors who poured in – expecting more of the same – were sorely disappointed.  By the end of March 1980, gold was back to selling at less than $500 an ounce, leaving investors who bought at the peak holding a stunning 40% loss for the quarter. Ouch.

Holding onto it didn’t help either.  By the end of the stock market run-up in early 2000, a single ounce of gold was selling for under $300 on the spot markets.

Today, of course, gold is hot; the shiny metal has tested all-time highs almost monthly, leaping from a little over $1,150 an ounce in late July to its latest all-time high, just over $1,365 in the middle of October.  Is it time to jump on this bandwagon and ride the gains up (according to some bullish newsletters) to $2,000 an ounce or higher?  Or is gold an overpriced investment ready to go bust?

Of course no one really knows. Obviously people disagree, as every time someone buys gold, someone else is selling it.

Things to consider

It isn’t real intrinsic demand driving the price of gold higher. Rather, it is investors (or speculators) who are buying at far higher prices than it costs to produce an ounce of gold.

There is no “shortage” of gold, as production over the past five years has been relatively stable at about 2,485 tons per year. In general, new mines are replacing the depleting production of current ones, so there has been little significant expansion in global output.

As prices rise, the market will probably see more recycled or scrap gold – a category which includes people selling gold jewelry. Between 2004 and 2008, recycled gold contributed 28% to annual supply flows.

There is no economic supply/demand imbalance, unless you count thousands of eager investors looking for more price run-ups or a hedge against inflation.

Is gold a reliable hedge against inflation? Since gold’s peak in the early 1980s, the annual inflation rate dropped, but cumulative inflation increased – just as gold was falling in value through the next two decades. According to InflationData.com, gold’s 1980 peak price on the spot market reached $2,250 if it were measured in today’s inflation-adjusted dollars, and the price fell to an inflation-adjusted $370 just two decades later. If gold had been an effective inflation hedge during that 20-year period, the price would have remained the same in inflation-adjusted terms.

So the numbers indicate that for long periods of time (but not always), gold can be a poor inflation hedge.   However, it does appear to be a pretty good “crisis hedge.” When people are concerned about a global liquidity crisis and/or an economic hangover (as they have been for the past couple of years), gold takes off. When the panic subsides, it is reasonable to expect that the price of the precious metal will decline.

Kenneth Rogoff is certainly not a “gold bug”, and he covers both sides of the argument in his article $10,000 Gold?

Pro

“In my view, the most powerful argument to justify today’s high price of gold is the dramatic emergence of Asia, Latin America, and the Middle East into the global economy. As legions of new consumers gain purchasing power, demand inevitably rises, driving up the price of scarce commodities.”

Con

“Gold prices are extremely sensitive to global interest-rate movements. After all, gold pays no interest and even costs something to store. Today, with interest rates near or at record lows in many countries, it is relatively cheap to speculate in gold instead of investing in bonds. But if real interest rates rise significantly, as well they might someday, gold prices could plummet.”

Conclusion

As Martin Feldstein wrote, “ Unlike common stock, bonds, and real estate, the value of gold does not reflect underlying earnings. Gold is a purely speculative investment. Over the next few years, it may fall to $500 an ounce or rise to $2,000 an ounce. There is no way to know which it will be. Caveat emptor.”

I certainly cannot predict whether the current fears will continue to drive gold higher. But history suggests that as soon as people start feeling more secure about the world situation, gold will suddenly lose its luster and leave its investors with significant losses.

If you buy gold now, are you investing or speculating? If you are speculating, is the best time to do it at near-record high prices?

One of the worst things investors can do, right now, is to pull out of the stock market because (they think) “the end of the world is upon us.”  The truth is that many people “throw in the towel” at just the wrong time.  And, certainly, the media, all too frequently, plays into (and plays up) that irrational fear, and usually at just the wrong time.

Several articles, had they been taken seriously, might have scared you right out of the stock market.  If you had followed the very typical story line of “now is a very risky time to be investing in stocks” you might have missed out on the best September since 1939.  In that single month, the Standard & Poor’s 500 Index gained 8.8%!

Here are just a few of the recent articles that could have led you astray.  (And note, please, the usage of the word “flee” in the title of the first two articles; I can’t help but relate the word “flee” to those old Godzilla movies, where everyone is haphazardly running for their lives.)

Small Investors Flee Stocks, Changing Market Dynamics, Wall Street Journal, July 12, 2010

“Many individual investors were tiptoeing back into stocks in the spring. Now, they’re running for cover again.”

“Individual investors were important market pillars in the 1990s, but their flight from stocks is changing the market dynamic.”

The article actually pictured a smiling couple who “sold the last of their stock holdings on May 20, moving the money to bonds, certificates of deposit and bond-like annuities.”  What unfortunate timing!  I’d be curious to see if they’re still smiling.

In Striking Shift, Small Investors Flee Stock Market, New York Times, August 21, 2010

Renewed economic uncertainty is testing Americans’ generation-long love affair with the stock market.

Investors withdrew a staggering $33.12 billion from domestic stock market mutual funds in the first seven months of this year, according to the Investment Company Institute, the mutual fund industry trade group. Now many are choosing investments they deem safer, like bonds.

The New York Times and The Wall Street Journal were not alone in trumpeting doom and gloom.  There have been similar articles in USA Today and Fortune.  Even The Atlantic weighed in with a fabulous title: The Great Stock Myth.

For an astute analysis (and a thorough debunking) of the Atlantic’s article, read Larry Swedroe’s August 30^th post, Are Stocks Really Doomed?

Conclusion

What can we learn from reading (and then completely disregarding) such inflammatory articles?  We learn that they are not at all helpful for long-term investing.  Articles of these types almost always appear after periods of low returns and/or increased volatility of stock prices.

What we know is that, yes, stocks are risky.  And, yes, prices fluctuate.  And, (a very emphatic) yes, we are all facing serious economic and political challenges.  And, perhaps some people should have a significant amount of their money invested in fixed income securities. 

But your portfolio should depend on an individual assessment of your goals, your time horizon, and your ability and willingness to accept risk.

Your long-term investment strategy should definitely not depend on – nor should it be influenced by – what you read in the media.

Determining when and how to effectively rebalance your portfolio requires careful monitoring of not only portfolio performance, but awareness of your tax status, cash flow, financial goals, and tolerance for risk.  The act of portfolio rebalancing results in transaction fees and has the potential to incur capital gains in taxable accounts. Thus, while there may be good reasons to rebalance, the benefits must outweigh the costs.

Given these challenges, a practical approach to rebalancing takes into consideration the occurrence of “triggering” points, yet provides enough flexibility that costs are effectively managed and minimized.

When to Rebalance

Defining triggering points helps us decide when to rebalance. Most experts recommend rebalancing when asset group weightings move outside a specified range of their target allocations.  This may be widely defined according to either a stock-bond mix or to a percentage drift away from target weightings for categories like small cap stocks, international stocks, and the like.

How to Rebalance

While rebalancing costs are unavoidable, several strategies can help minimize the impact:

• Rebalance with new cash. Rather than selling over-weighted assets that have appreciated, use new cash to buy more under-weighted assets; this reduces transaction costs and the tax consequences of selling assets.
• Whenever possible, rebalance in the tax-deferred or tax-exempt accounts where capital gains are not realized.
• Incorporate tax management within taxable accounts, such as strategic loss harvesting, dividend management, and gain/loss matching.
• Implement an integrated portfolio strategy. In other words, rather than maintaining rigid barriers between component asset classes and accounts, manage the portfolio as a whole.

Conclusion

While there are good reasons to adjust portfolio risk by rebalancing, it does incur real costs that can detract from returns. A good strategy includes determining which investment components can acceptably drift, and adopting tax-saving and cost-saving strategies during rebalancing. In helping our clients rebalance, we strive to develop a structured plan that remains flexible to each individual’s unique blend of goals, risk tolerances, cash flow, and tax status.

No one knows where the capital markets will go—and that’s the point. In an uncertain world, investors should have a well-defined, globally diversified strategy and manage their portfolio to implement it over time. Rebalancing is a crucial tool in this effort.

Moreover, if and when your overall financial goals or risk tolerance change, you have a foundation for making adjustments. In the absence of a plan, adjustments are a matter of guesswork.

While global diversification gives investors a valuable tool for managing risk and volatility in a portfolio, it requires maintenance.  Over time, asset classes have different returns. This is inevitable and, in fact, desirable. A portfolio that holds assets that perform dissimilarly will experience less overall volatility, and that results in a smoother ride over time.

However, dissimilar performance can also change the integrity of your asset mix or allocation – a condition known as “asset drift.” As some assets appreciate in value and others lose relative value, your portfolio’s allocation changes, which affects its risk and return qualities. If you let the allocation drift far enough away from your original target, you end up with a very different portfolio.

If you do nothing, “asset drift” will cause your portfolio to deviate from your long range plan and risk tolerance.  As I said, even a well diversified portfolio requires maintenance.

Rebalancing is the remedy. To rebalance, you sell some assets that have risen in value and buy more of assets that have dropped in value. The purpose of rebalancing is to move a portfolio back to its original target allocation. This restores strategic structure in the portfolio and puts you back on track to pursue long-term goals.

Why rebalance?

At first glance, rebalancing seems counter-intuitive. Why sell a portion of outperforming asset groups and acquire a larger share of underperforming ones? A common reaction is to want to buy what has gone up, because you think it will continue to outperform.  This logic is flawed, however, because past performance may not continue in the future.  In reality, there’s no reliable way to predict future returns.  The old stock broker mantra (slightly modified, simply because you can’t predict the future) holds true, “Buy lower, sell higher.”

Equally important, remember that you chose your original asset allocation to reflect your risk and return preferences. Rebalancing realigns your portfolio to these priorities by using structure, not recent performance, to drive investment decisions. Periodic rebalancing also encourages dispassionate decision making – an essential quality during times of market volatility.

Conclusion

In the real world, portfolio allocations can be complex, incorporating not only fixed income and stocks, but also the multiple asset groups within equity investing. And, of course, tax considerations are very important.

In summary, to ensure that a portfolio’s risk and return characteristics remain consistent over time, a portfolio must be rebalanced.  Rebalancing is a tool to control risk and also an antidote to becoming too optimistic or too pessimistic.  You are, in effect, buying low and selling high, whether you want to or not.

Determining when and how to effectively rebalance is the subject of Part 2.

The Stock-Bond Decision

When meeting with clients, I emphasize that choosing a basic stock-bond mix is a very important first step in effective and productive portfolio design. Unfortunately, I sometimes encounter people who have allocated their portfolio at either extreme – 100% in stocks or 100% in money market accounts/bonds.  Very few advisors would ever recommend either approach.

Although the stock-bond decision may appear simple, it can have a profound impact on your wealth.  Studies have proven that nearly 90% of a portfolio’s long-term results are directly linked to asset allocation, and the right stock-versus-bond mix should be your first deliberate and strategic decision.

The Rationale

Because neither I nor anyone I know can predict the future, I believe in having a diversified portfolio that includes both stocks and bonds.  I “dial down” total risk by adding fixed income to the stock market mix.  Quite simply, the greater the bond allocation relative to stocks, the less risky the portfolio, but the lower the total expected return.  On the other hand, the greater the stock allocation relative to bonds, the higher the portfolio’s expected return, and the higher the associated risk.

So, how do you confidently allocate between stocks and bonds?  One method is to use model portfolios to illustrate the risk-return spectrum over time. For simplicity and clarity, the highest risk portfolio holds 100% in a stock index, while the least volatile portfolio holds 100% in high quality bonds. Between these extremes lie other stock-bond allocations, such as 80/20, 60/40, 50/50, 40/60, and 20/80.  Comparing past results side by side is illuminating and quite helpful in the decision making process.

Certainly, relying on historical performance is not foolproof, because past results are not a guarantee of future performance.   But if you compare the average annualized return and volatility (standard deviation) of each model portfolio since 1970 (for example), you have an idea of what relative risk you can expect and whether or not you can accept the potential loss.

Lately, I have found that showing how portfolios did in 2008 is very helpful in illustrating the risk-reward tradeoffs.  Analyzing just that specific year shows that diversification neither assures a profit nor guarantees against loss in a declining market, at least in the short term.

For example, a portfolio with a stock allocation of 80% declined 30% in 2008, while a portfolio of 60% stocks “only” declined by 21%.  Many people can live with a 21% decline, knowing that markets do rebound and the long term outlook is positive.  On the other hand, suffering a 30% loss (or more) could have tipped some investors into panicking and getting out of the stock market entirely, much to their chagrin today.

Refining the Stock Allocation

After establishing the basic stock-bond mix, I turn my attention to refining the stock allocation.  Depending on an investor’s individual profile, I may overweight or “tilt” the allocation toward riskier asset classes that have a history of offering average returns above the market.

Research published by Eugene Fama and Kenneth French reveals that small cap stocks have had higher average returns than large cap stocks, and “value stocks” have had higher average returns than growth stocks.  By holding a larger portion of small cap and value stocks in a portfolio, an investor increases the potential to earn higher returns for the additional risk taken.

The final step in refining the stock component is to diversify globally.  By holding an array of equity asset classes across domestic and international markets, you can reduce the impact of underperformance in a single market or region of the world.  And lest you worry about the global recession, last year developed and emerging markets grew at a rate higher than domestic markets, by 27.7% and 74.1%, respectively.

Conclusion

Over short periods of time, returns on stocks are quite variable; in other words, in any year we don’t know whether stocks will produce good results or not.  But, over a longer period of time – and this has been historically proven – stocks provide higher average returns than low-yielding bonds.  That’s why I generally recommend that investors with a long investment life ahead of them focus on achieving the higher long-term returns through investment in stocks.  As your time horizon or risk tolerance changes, you can reallocate your portfolio’s risk more in favor of bonds.

Summary

The stock-bond decision drives a large part of a portfolio’s long-term performance. During discussions with clients, I have found that examining different stock-bond combinations can help them visualize the risk-return tradeoff as they consider the range of potential outcomes over time. Once a mix is determined, it can guide more detailed choices of asset classes to hold in the portfolio. And, as one’s appetite for risk shifts over time, the allocation decision can and should be revisited.

The author of The Only Guide to a Winning Investment Strategy You’ll Ever Need: The Way Smart Money Preserves Wealth Today, Larry Swedroe always writes clearly and succinctly, and he conveys a great deal of information in a short time. 

This post is a summary of his excellent column Bear Markets: A Necessary Evil.  It is the best article I have read on investing strategy in general and during a Bear Market, in particular.

If you are a serious student of investing, I highly, highly recommend that you read the entire article, which obviously has more detail than this summary.

A necessary evil can be defined as an unpleasant necessity; something that is unpleasant or undesirable but is needed to achieve a result. An example of a necessary evil might be taxes. Investors should also view bear markets as a necessary evil.

His key point is important, but subtle:

Perhaps the most basic principle of modern financial theory is that risk and expected return are related. We know that stocks are riskier than one-month Treasury bills (which is considered the benchmark riskless instrument). Since they are riskier, the only logical explanation for investing in stocks is that they must provide a higher expected return. However, if stocks always provided higher returns than one-month Treasury bills (the expected always occurred) investing in stocks would not entail any risk—and there would be no risk premium.

Bear markets are necessary to the creation of the large equity risk premium we have experienced. Thus, if investors want stocks to provide high expected returns, bear markets, while painful to endure, should be considered a necessary evil.

Risk Premiums and Investment Discipline

“The bottom line is that the outperformance of stocks relative to Treasury bills” entails risk.

And it is a virtual certainty that the risks will show up from time to time. Unfortunately, we cannot know when, or for how long, the periods of underperformance will last, nor how severe they will be.

It is during the periods of underperformance when investor discipline is tested. Unfortunately, the evidence suggests that most investors significantly underperform both the stock market and the very mutual funds in which they invest.

The reason for the underperformance is that investors act like generals fighting the last war. They observe yesterday’s winners and jump on the bandwagon— buying high—and they observe yesterday’s losers and abandon ship—selling low.

Why most investors fail

1. Investors allow their emotions to impact their investment decisions. In bull markets, greed and envy take over and risk is overlooked. In bear markets, fear and panic take over, and even the well-thought-out plans can end up in the trash heap of emotions.

2. Investors are overconfident of their ability to deal with risk when it inevitably shows up.

3. Investors often treat the likely (stocks will outperform Treasury bills) as certain and the unlikely (a severe bear market) as impossible. The result is that they take more risk than is appropriate—and when the risks show up they are “forced” to sell.

The Keys to Successful Investing

1. The first key to successful investing is to have a well-thought-out plan. That plan includes an understanding of the nature of the risks of investing. That means accepting that bear markets are inevitable and must be built into the plan.

2. Those investors that avoid excessive risk taking are the ones most likely to be able to stay the course and avoid the buy high/sell low pattern that bedevils most investors.

3. Understand that trying to time the market is a loser’s game. A loser’s game is one that while it is possible to win, the odds of doing so are so low that it is not prudent to try.

Summary

It is difficult for most individuals to control their emotions—emotions of greed and envy in bull markets and fear and panic in bear markets.

Bear markets are a necessary evil in that their existence is the very reason that the stock market has provided the large risk premium and the high return that investors have had the opportunity to earn.

But there is another important point that investors need to understand about bear markets. Investors in the accumulation phase of their investment careers should actually view bear markets not just as a necessary evil, but also as a good thing. The reason is that bear markets provide those investors (at least those that have the discipline to adhere to their plan) with the opportunity to buy stocks at lower prices, increasing expected returns.

It is only those that are in the withdrawal phase (e.g., retirees) that should fear bear markets. The reason is that withdrawals make it more difficult to maintain the portfolio’s value over the long term. Thus, investors in the withdrawal phase have a lesser ability to take risk and should build that into their plan.

The bottom line for investors is this: If you don’t have a plan, immediately sit down and develop one. Make sure the plan anticipates bear markets and outlines what actions you will take when they occur (doing so when you are not under the stress that bear markets create).

To repeat, this entire post is a summary of Larry Swedroe’s article.

The words are his; I just happen to agree with them wholeheartedly.

“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” – Warren Buffett.

The title of this post (and the previous one) is intentional. When market prices plummet, as they do from time to time, it is important to avoid panic. Do not discard your well-thought-out asset allocation and your long-range plan. And don’t even think of using the phrase, “In the long run, we are all dead.” That’s a rationalization for following your natural inclination of reacting to fear.

How do we avoid acting emotionally? Well, it helps if we have an understanding of investor psychology (especially our own) but also the perspective of market history. This post goes into each realm.

For an understanding of investor psychology, a great place to start is with Jason Zweig’s book Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich. In this book, he discusses how neuroscience, economics and psychology explain how we make good or bad investment decisions.

Zweig’s weekly column, The Intelligent Investor, published in The Wall Street Journal is always interesting, because he is insightful and brings an independent approach to the investing scene. This weekend’s article entitled Should You Fear the Ostrich Effect? may be particularly relevant. If you don’t have access to the Wall Street Journal, here’s a summary, as well as my analysis.

Zweig observes that investors pay much less attention to their portfolios when the market news is bad. The term “ostrich effect” was coined by behavioral economist George Lowenstein of Carnegie Mellon University. Lowenstein has done extensive research measuring the phenomenon.

Zweig comments that, “Turning yourself into an ostrich doesn’t make your losses go away, but it does enable you to pretend they aren’t there.”

Moreover, Zweig maintains that ostrich-like behavior isn’t all bad.

“Experiments by psychologist Paul Andreassen have shown that the more news that investors get on their holdings, the more they trade and the lower the returns they earn. When your head is stuck in the sand, you can’t open your mouth to trade.”

Absolutely! As Eugene Fama, Jr. said at a recent NAPFA meeting, “Money is like soap; the more you touch it, the less you have.”

Of course, Zweig is not recommending that you completely ignore the news and, therefore, reality, and neither am I. But, if you have a long-term approach and a well diversified portfolio, I believe that you don’t need to follow the news day after day, nor is it even recommended. It may just get you upset at the wrong time, enticing you to react inappropriately.

“When the headlines are overwhelmingly negative, as they are now, the market tends to feel riskier than it actually is. (The time to worry is when no one seems worried, not when everyone does.)”

That bears repeating. “The time to worry is when no one seems worried, not when everyone does.” That has been a favorite phrase that I frequently use with clients.

Zweig invites us to:

“Take a few moments to go back in market history and see how stocks did after other periods of despondency like 2002, 1998, 1991, 1987, 1982, 1974 and so on. If history is any guide, your inclination to act like an ostrich is a strong indication that the market is about to turn into a phoenix.”

Well, I have done what he suggested. What follows is my analysis.

While the S&P 500 had an average annual return of 11.1% from 1970 to 2007, the numbers for the year after recent market declines are much higher.

Source: Standard & Poor’s, cited in Simple Wealth, Inevitable Wealth, by Nick Murray and Dimensional Fund Advisors’ Matrix book.

Be Careful How You Use This Analysis

Please note that these numbers are merely illustrative, because we are using calendar years after the decline, and the declines did not end conveniently on December 31st. Still, in the calendar year following a Bear Market, the average return was 26%. This is an impressive number and makes Zweig’s point.

However, there is another caveat. We are looking back to notice what happened after a market decline. In choosing 1974 or 2002, for example, as our ending points, we are in effect doing a bit of data mining. (We are using the proverbial 20/20 hindsight.)

Recall, though, that 1973 and 1974 were both bad years. Certainly, no one could have known that in advance. So if you were thinking about this in 1973, and you saw a decline of 14.7% for that year, you might have thought that 1974 would be a pretty good year. It definitely was not — the S&P 500 declined by a further 26.5%!

Similarly, 2000, 2001, and 2002 were all down years. If you had thought in 2001 that the worst was over, you would have been spectacularly wrong! After two bad years, the S&P 500 declined a further 22.1% in 2002!

So while I acknowledge that markets tend to do very well after a spate of declines, unfortunately, we cannot know whether the bottom has been reached, at any given point in time.

Buy-and-Hold

But we do know that if you had gotten out of the market in 2002, for example, as so many people did, you would have lived to regret it. The next year, 2003, was a very good year for the S&P 500 with a gain of 28.7%.

Numbers like that reinforce our buy-and-hold philosophy. We don’t try to use “Market Timing” to decide when to get out of the market and when to get back in. It’s impossible to know when to do that. As Jane Bryant Quinn said, “The market timer’s Hall of Fame is an empty room.”

Diversifying Beyond the S&P 500

As an important aside, many indexes did much better than the S&P 500 Index in 2003.

Please note that these eye-popping results came after a very difficult multi-year Bear Market. Do not expect these results to repeat in the future. And you can not invest directly in an index.

However, these results are indicative of why we recommend diversifying in many more asset classes than just the S&P 500.

“Past Performance is No Guarantee of Future Results.” The SEC makes us say it, and it happens to be true.

Finally, read the quote by Warren Buffet at the top of this post. Do you even imagine that the “Sage of Omaha” is selling today?

“Without a rock-solid belief in the fundamental principles that undergird an intelligently crafted portfolio, weak-kneed investors face the likelihood of a disastrous whipsaw.” – David Swensen

Yesterday’s Los Angeles Times online article “Another sucker’s rally? Stocks are back in bear territory” declared that a bear market has returned. This won’t be the last article you see of this kind. This is just a guess, but watch for headlines that scream, “The Bear (Market) is BACK! What should you do NOW?” These articles sell publications. So what does this “bear market” actually mean to you?

A bear market is a prolonged period in which investment prices fall, accompanied by widespread pessimism. It is typically defined as a decline in a stock index of approximately 20% or more from a previous high.

A stock market decline of that magnitude is certainly noticeable. But once it has already occurred, what should you do? Probably nothing, especially if you have a well-thought-out strategy and properly diversified portfolio based on your individual circumstances.

The Media

Newspapers, magazines, and TV programs make the declaration of a bear market sound significant. They can always find someone who will compare this decline to past ones and make predictions about just how bad things will be. But the media’s attention to a bear market may be a distraction, it may be misleading, and it could lead you to do something harmful to your economic health. It could convince you to sell.

Yes, the stock market has declined more than 20% from its high, but did you actually buy at the high? It would have been quite difficult to have such exquisitely bad timing! Were you 100% in stocks, as if you were channeling a river boat gambler? I sure hope that you weren’t borrowing money to buy stocks.

As for going forward, please realize that it is impossible to know whether the decline will continue or reverse. Magazine articles or TV commentators may talk knowingly about the causes of this bear market, and why it will continue, but my advice is to ignore them.

We’ve had them before

According to Nick Murray’s Simple Wealth, Inevitable Wealth, not counting the current decline, we have had 12 bear markets since World War II. So these declines are actually quite common. And they have all been temporary.

In the past, we’ve had steep stock market declines caused by wars, high inflation, OPEC embargoes, credit crises, over-speculation, corporate overreaching and fraud. We’ve had assassinations, an impeachment and a president resign. We have had hedge funds implode, and seemingly great institutions disappear. Each time, while living through the terrible stock market, it seemed like that was the first time that such a negative constellation of events had ever occurred. But that wasn’t so. Our economy survived and stock prices recovered, as investor confidence returned.

How long withh this bear market last? No one knows! No one. Talking about the “average” decline is not particularly useful. Some bear markets have been short, some very steep, some unnervingly long and relentless.

Seeing your wealth decrease day by day is no fun. But a bear market is something you have to accept in order to get the long term (higher) returns associated with stocks. At least that is the way it has been in the past.

Feel the Fear But Don’t Act on It

With prices declining, and everyone talking about it, fear takes over, quite naturally. The L.A. Times companion article Investors flee as fear factor swamps markets worldwide is all about fear. In a relatively short piece, I counted the word “fear” 8 times, not to mention “worried” “nervous” and “hammered.” And what a litany of terribles. We’re doomed, doomed!

The final quote, “You tell me — why would you want to buy something now?”

I don’t know, maybe because stocks are on sale with prices reduced?

If you act on the fear, and sell in panic, you have lost. You may think that you will buy back, when things look safer, but the odds of your actually doing so are very small.

Conclusion

It is not easy to have the courage to ignore the pessimism, but over the long term, returns from stocks have more than made up for the periodic (and temporary) bear markets. Will the future look like the past? My guess is Yes.

To be continued …