It’s Just the Opposite

Story Highlights:

• Fear says if you've followed a particular strategy and lost money, the strategy must be wrong. But be very careful to check the facts.
• Historically, bulls' gains outweigh bears' losses, over time stocks are the best liquid asset class, and diversification helps reduce risk.
• An excellent time to invest in stocks is when the most negative stories emerge. When folks think stocks are done forever—get ready for the opposite.

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In the depths of a bear market, it's easy to question everything, including basic strategy. We've seen plenty of recent news stories touting the end of stock investing—forever. Overblown sentiment is par for the course in the best and worst of times, and a factor reinforcing a common investor mistake: Ebulliently buying high and fearfully selling low.

Fear says if you've followed a particular strategy and lost money, the strategy must be wrong. But be very careful to check the facts. Investments will always involve the risk of loss. If you lost money in the last year, you're not alone. Many investors also lost money in the extended bears of 1973-1974, 1980-1982, or 2000-2002. Yet during the bulls between those bears, stocks' gains outweighed earlier losses. This time should be no different.

Further, investors seeking long-term growth ought to be in stocks more than they are out. Keeping an eye for the larger downtrends and appropriately shifting asset allocation is part of a good active strategy if you're skilled at it. Dodging even one bear market period greatly increases the chance you'll beat the market in the long run. Not dodging any means you're still likely to beat all other similarly liquid asset classes. Over time, stock investing has historically outperformed any reasonable alternative—hands down.

Still, naysayers will surface. We recently read one argument claiming that over the last 28 years, as interest rates have fallen, US Treasuries beat stocks handily. But that claim rests on a flawed comparison of passive stock investing (staying in for the bad and good) to near perfectly executed active Treasury investing (getting it exactly right year in, year out) and cherry picks the period (right now stocks are abnormally depressed, Treasuries at a probable peak). Hardly a fair evaluation.

All that said, there are risks. Active portfolio management seeks to maximize return and minimize risk through diversification. It's impossible to eliminate all risk from investing, but diversification can dramatically reduce the risk associated with individual countries, sectors, or stocks. Diversification is prudent because no matter how good an investor is, there's always a chance they'll be wrong. Don't let being wrong wipe you out. There are those doubting this rule of thumb right now. Ignore, ignore, ignore! A few famous investors, like Warren Buffet, have gotten rich with fewer eggs in their baskets (even though Buffet's main holding, Berkshire Hathaway, is diversified among a number of companies), but those cases are rare and involve at least equal portions of luck and skill. Mounds of evidence and study show us diversification is important for a well-constructed portfolio. It is one of the bedrock, and still relevant, findings of Modern Portfolio Theory.

Stock volatility can be nauseating, shaking investors out of the market exactly when they should stay in—like today. An excellent time to invest in stocks is when the most negative stories emerge. Expect more fear in the future. But when folks think stocks are done forever—get ready for the opposite.