• Martin Fridson, CFA

Why you should not listen to the doomsayers.

Every so often, on CNBC or in the Wall Street Journal, some investment luminary declares that it is time to get out of the market. The advice is typically backed up with a dire pronouncement about the current economic outlook. What choice does an average investor have but to go along when an acknowledged expert makes such a definitive statement? In truth, however, selling everything and going to cash is not the appropriate response. Why you’re different from that person on TV

It is important to realize that the celebrities who periodically advocate pulling out of the market are typically professional investment managers or consultants to professional investment managers. Their concerns are very different from those of the ordinary investor. They have to be concerned not only with building financial security for themselves over the long run—it would be interesting to ask them if they sold all their positions in their 401(k) accounts—but also with maximizing total return over the next year or even the next quarter. Unlike the average investor, the pros need to consider how their investment decisions will affect the size of their assets under management. (AUM is the sum total of money in their mutual funds, hedge funds, or institutional portfolios.) In theory, it makes sense for these people to try to time the market, moving to cash when they expect prices to fall, then shifting back into stocks and bonds when they expect prices to rise. In practice, no professional succeeds in market-timing over any extended period. But if they could time the market accurately, they would be able to advertise superb performance records. That would bring in many new clients, enabling them to earn higher management fees. Incidentally, if a mutual fund manager’s market-timing strategy fails, the results are not fatal. The mutual fund company can simply merge the unsuccessful fund into one that has fared better, thereby erasing the performance record of the poorer performer. As for a hedge fund that miscalls the market direction, it is just a matter of waiting until its luck improves. (In any case, hedge funds generally lock up their investors for periods of a year or longer.) There are plenty of investors who are willing to put their money with whichever manager has a hot hand at the moment. If you have investments outside of an IRA or 401(k), you differ from money managers who handle the investments of pension funds and endowments. These institutional investors are not taxed on capital gains. They can dump securities that have appreciated without incurring a financial penalty. In contrast, if you sell securities at a gain as part of a market-timing play, it will cost you come April 15. Market-timing is particularly chancy if your primary objective is high current income, consistent with preserving principal. Suppose, for example, you sell preferred stocks yielding 6% and switch into Treasury bills yielding 2.9%. While you await the “right” time to jump back into the market, you are sacrificing income that may exceed any benefit from timing the market correctly (which is not likely to happen, in any case). Bear in mind that as long as the securities are carefully chosen, your income should remain fairly steady through the inevitable, cyclical ups and downs in the market value of your portfolio. Your spending power is determined by your dividends and interest, not by the price that the market puts on your portfolio on a given day. Studies have shown that investors in mutual funds earn lower returns on average than the funds themselves earn. [1] How is that mathematically possible? It is because the investors consistently buy at the top and sell at the bottom in ill-fated attempts to time the market. This is a trap you should definitely avoid falling into. Long-term investing works We are most certainly conscious of the current risks in the market. Inflation remains stubbornly high and it is likely, in our view, that the Federal Reserve’s tough stance against it will push the U.S. into a recession by 2023. We have therefore positioned our clients’ portfolios more conservatively than we would if we perceived an all-clear signal on the economic front. We currently have a greater emphasis on protecting principal than at other times. Cash and short-term, high-quality bonds have a role in that strategy. It would not serve clients’ interests, however, to go to the extreme of 100% cash that some pundits are recommending to professional money managers who compete to produce the best three-month results. We aim to develop very long-term relationships with everyone who entrusts their wealth to our stewardship. The surest way to achieve that objective is to invest in a way that ensures a secure financial future for our present clients and for future generations. GRAPH 1 – S&P Index return ranges (minimum and maximums) Over longer periods of time positive annualized rates of return are much more frequent (86%) than negative ones (14%).

The four lowest 10-year rolling returns were all associated with the Great Depression of the 1930s. All other negative 10-year rolling returns were connected to the 1970s stagflation, the Great Recession of 2008-2009, or the economic slump brought on by the end of World War II. Building wealth over the long run requires the proper perspective. Stock returns vary widely from year to year. From 1938 to 2021, one-year returns on the S&P 500 ranged from 46.59% to -47.07%. Returns are much steadier and more reliable over decade-long periods. Over the same span, rolling 10-year rolling annualized returns on the S&P500 ranged between 16.04%% and -5.93%. It is not by chance that returns were positive in 86% of those ten-year periods. Over time, stocks go up as a function of the earnings growth of the nation’s leading companies. In turbulent periods, it is best to keep in mind a saying of Warren Buffett: “The stock market is designed to transfer money from the active to the patient.” He recommends that you “invest with a multi-decade horizon.” That may not be feasible for the fund managers you see on CNBC, but the freedom to maintain a long-term perspective is one advantage you have over them. [1] See https://www.wsj.com/articles/BL-MBB-49384.

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