Wednesday, March 13, 2013

Ignoring the market and economy

A short while ago, Bill McBride over at Calculated Risk posted an article on Business Cycles and Markets . The article asks why we care about exactly when recessions start or stop or whether we’re in a recession right now. Of course, the answer is that, if one can know when the start of a recession is in real time, then the investor can close his positions and reopen them at the bottom. And sure enough, if an investor could do that he would make a whole lot more money from his investments than if he just held through the recession. Interestingly, in the period starting in 2000, though, an investor would have done better if he missed the timing some.

Then I got to thinking about the last recession, and after stocks had lost nearly half their value, people were asking me what to do. My response was, “Well, nothing now, other than keep investing in whatever you’ve been investing in. If you thought it was a good investment before, then it’s an even better investment now.” I don’t know how many people actually did that, and nobody has thanked me for that bit of wisdom, even though, if they followed my advice, their investments would be worth a lot more now than they were before the crash with their added investment at much lower prices.

Then I started thinking about how the stock market is just now approaching the same level as it was in 2000 or so, for the second time. And people have said to me that it seems like they’re not really making anything in stocks. Of course, they’re not if they keep selling when the market tanks. I actually think they only think that because they see that the stock market is still not any higher than it was back in 2000.

And, eventually, I started thinking “What if someone just regularly invested on the first trading day of the year, oblivious to whatever was going on at the time? And what if he was the unluckiest person and always bought at the high for that day? And what if, in fact, he was so unlucky he only started investing in January 2000?” For one thing, he would have slept a lot better during the dot com bust and financial crisis, rather than lying awake worrying about what to do. For another, he wouldn’t have any idea whether he was making money or not. He at least would be oblivious to the fact that stocks have pretty much not gone anywhere since 2000.

So, I decided to have a look. For simplicity, I just assumed that dividends were paid at the end of the year, and reinvested. As it turns out, our uninformed investor would have made a 1.6 percent annualized return over this period of time, and this return is mostly due to dividends. Bear in mind, though, that this is just about the worst case scenario for an investor. He started investing at the top of the dot com bubble, and always bought at the highest price on the first trading day of the year.

So, I don’t know if there’s really any lesson in that. Of course, if I went back further, the results would have been significantly better. And it’s entirely possible to have done a lot worse. Panicking at the bottoms comes to mind as a major problem our investor friend isn’t in danger of having. And, the way the market is acting these days, it’s possible our hypothetical investor might end up being a lot better off if he keeps with the plan. Well, maybe.

EDIT: Soooo, I made a bit of a blunder on this post.  In figuring that 1.6 percent return, I just calculated the return on the total investment over 13 years, which of course is incorrect.  It was late when I wrote it, and it's even later now so I'm not inclined to fix it.  The point is still the same.  Most of the returns resulted from dividends, which isn't surprising given that stocks have just risen again to the same level.

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