Wall Street types always say they've made the most money by buying stocks in tough times. They're saying it now, but the point deserves some rumination.
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"If I make a decision to buy a stock and feel comfortable, I'm probably wrong," says John Snyder, manager of the (SOVIX) John Hancock Sovereign Investors fund. "The best decisions come when you're nervous, when it's gut-wrenching. That's when you make your most profitable decisions."
Anybody thinking about buying shares today better hope that's more than bluster, because stocks are in the throes of a fairly serious blue period. When this month started, the
had already lost a quarter of its value over the past year. And in the wake of last week's terrorist attacks, rattled investors have shaved off an additional 7% in just three trading days. So, there's a strong case for plunking your money in the bank or a money market account, as many have done this year, rather than a stock or stock mutual fund. But there's an argument for long-term investors to keep buying stocks, too.
Let's look at each and then think about how to proceed.
Saying the past three years have been difficult for stock investors is like saying it would be a little tough to scale a glass pyramid wearing rollerskates. Even though the S&P 500 gained 21% in 1999, three-month CDs would've made you more money over the past three years than stocks, according to Chicago fund tracker Morningstar.
You remember CDs, or certificates of deposit. They're essentially bank accounts where you hand over some money and agree not to withdraw it for a few months or years in return for a slightly higher interest rate than you'd get in a regular passbook account. If you kept renewing a three-month CD, it would've paid out about 5% annually over the past three years. That beats the S&P 500 by a little more than a percentage point.
And over the past year, the same CD would've led the S&P 500 by almost 20 percentage points. Keep in mind that the FDIC insures the money you have in the bank up to $100,000, a luxury not afforded to holders of
and ravaged tech funds.
Yes, stocks' three-year return figure is startlingly bad, but it's not reason to abandon stocks if you're investing for the long term (10 years or more). Stock investments have historically doubled a CD's annual gains, so while their current malaise is extreme, it's also extraordinary.
"It's ugly," says Scott Cooley, a senior fund analyst at Mornignstar. "But it's good to keep in mind that even though the long-term return on stocks is in the 10%-11% annualized range, there aren't many years that are 10% or 11% returns. There's a lot of bouncing around on the way to those returns."
A $10,000 investment in the
Vanguard 500 Index fund, which tracks the S&P 500, would've grown to more than $46,000 over the past 10 years. The same investment in a three-month CD would be worth about $16,600.
History shows that it can make sense for fund investors to buy stocks at a time like this, as long as you take a slow and steady approach. Back on Oct. 19, 1987, the stock market dropped 22.6%. If you'd been unfortunate enough to invest money in a stock fund the day before that, you absorbed a vicious beating.
But if you'd followed the dreary tenets of fund investing -- hold on to your shares and invest a set amount each month -- things wouldn't have turned out so badly. If you invested $3,000 in the Vanguard 500 Index fund the day before that steep drop and invested just $100 each month since, your account would be worth more than $64,000. Yes, you lost nearly 22% of your money in the first three months, but things worked out.
If you want less risk, let's assume you made the same investment, but split the money evenly between the Vanguard 500 fund and the
Pimco Total Return fund, an intermediate-term bond fund. You'd still end up with more than $53,500 -- and you would've lost only about 9% in those first 30 days.
There's more than history stacked against CDs in their battle to keep outperforming stocks, too. The
continuing rate cuts are designed to lower the interest rates paid by money market accounts and CDs. The plan, which may or may not work, is to make us all put money back into the stock and bond markets.
The bottom line is that whether you buy shares of a stock fund or stay on the sidelines should be determined by when you'll need the money you're investing, not on how lucky you feel one day or another.
"I have no idea what the next year will bring," Morningstar's Cooley coolly confessed. "But I feel pretty good by investing for my retirement based on the idea that stock prices will be higher 10 or 20 years from now."
If you have that kind of time, a monthly investment program into an index stock fund or a blend of stock and bond funds probably makes sense. If not, head to the bank.
Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
email@example.com, but he cannot give specific financial advice.