Did you pass the test? Did you know you were taking a test?
The test occurred in December, when stocks sharply declined. As an example, S&P 500 Index funds were down 9% for the month. The annual high for S&P 500 Index funds share prices was September 20. Prices then declined 19.4%, hitting their lowest point for the year on December 24.
That is what I call the Patient Investor Test; during the December declines, which investors held stock investments and which investors transferred out of stocks. Who was a “market timer” and who was a “patient investor?”
Market timers try to sell in advance of a market decline and reinvest before stocks recover. That is extremely difficult for even the best professional investors. It requires two accurate forecasts: when will the market begin declining and when will it begin recovering. It also requires nerves to buy stocks when the market is crashing and other investors are selling.
Patient investors use a buy-and-hold strategy. They are content to stay invested in stocks during stock market declines. They see stocks as a good long-term investment and declines as temporary.
Historically, investors in well-diversified and well-managed stock portfolios did not have to buy and sell to profit. They only had to buy and hold for a sufficiently long period of time. Their patience was ultimately rewarded. Market timing wasn’t needed.
The last two months are a good example. December 2018 was a horrible month for stocks. But January 2019 was a great month. S&P 500 Index funds increased 8% in January. Patient investors who stayed in S&P 500 Index funds saw a 12 month (January through December 2018) loss turn into a 13-month (January 2018 through January 2019) gain of 3.3%.
Most stock and bond indexes benefited from a strong January performance, not just the S&P 500.
Former stock fund investors who switched out of stocks in December now face a dilemma; should they:
- Stay out of stocks and stock funds, because many stocks markets are overdue for a decline greater than 20%, world events seem unusually scary and the increase since the September 20 low point makes stocks even less attractive, or
- Transfer back to stock investments now, hoping that the 19% September to December decline was the worst that will happen for a long time. Unfortunately, that means paying more for the shares purchased now than for the shares sold in December. Or, “selling low and buying high,” a strategy which always loses money.
That is a tough decision.
Of course, past performance is no guarantee of future performance. January may be one good month during a long decline. Stock investors should be prepared for these long declines. Stock market volatility (the constant increases and decreases in values) and sharp declines over short or long time periods are not a risk; they are a certainty. That is why patience is required.
According to well-known investor Warren Buffett: “The [stock] market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.”
This is for educational purposes only. To learn more about the topics mentioned and if they are suitable for you, consult an appropriate professional. Tax laws can change at any time.
Any information provided in this presentation has been prepared from sources believed to be reliable, but is not guaranteed and is not a complete summary or statement of all available data necessary for making an investment decision. Any information provided is for information purposes only and does not constitute a recommendation.
Arthur Stein and Arthur Stein Financial, LLC are not authorized to give legal or tax advice. For information on your specific situation, please consult your tax advisor regarding any tax implications and your attorney for legal implications. As required by the US Treasury Regulations, you should be aware that this presentation is not intended to be used and it cannot be used for the purposes of avoiding penalties under federal tax laws.
Keep in mind that:
- Past performance is no guarantee of future performance;
- Investments involve the risk of loss of principal and earnings;
- ETFs, mutual funds, money market funds, etc. are not guaranteed by the US Government, the FDIC, a bank or anyone else.
- “Average annual return” evens out variations in the actual year-to-year returns.
- ETFs, mutual funds and individual stocks and bonds fluctuate in value and there will always be times when they lose value.
- None of the information provided is necessarily relevant to anyone’s personal situation. Circumstances differ among individuals and you should not assume that these generalizations or information apply to you.
- Investments mentioned may not be suitable for all investors.