New Market Highs: Time to Sell?

The Dow, which serves as a proxy of the stock market overall, just set a new nominal record today. Obviously, the market will do this often over time (assuming it always continued to go up over the long-run). However, each time that it reaches a higher after being significantly below that, it tends to make headlines.

When the market is reaching a new high, people typically have one of two reactions:
1. Wow, the stock market sure has risen a lot. Maybe it’s time that I sell some of my stocks to capture my gains.
2. The stock market sure has been climbing! Maybe I should change my allocation to give a heavier weighting to stocks to take advantage of the climb.

It’s natural to have these reactions. Every time the media reports on a new high or low I think “Should I buy? Should I sell?” But then I settle down and realize that there’s absolutely nothing that I need to do. The portfolio allocation that worked yesterday will work today. Let’s briefly look at why it’s difficult to time the market and why it typically doesn’t work out.

  • If market professionals aren’t able to time the market, then why do you think you can? Each time you buy a stock, someone else is selling. With the volume traded by professionals, chances are high that the person on the other end of the transaction is a professional who dedicates all of his time to following the market.
  • The returns of the market are attributed to just a handful of the total days. In one study, the 100 best days out of the previous 100 years accounted for more than 99% of the returns in the market.
  • You have to be right…twice. Not only do you have to change your allocation at the correct moment the first time, but you have to switch it back at the right time later. That’s placing a lot of confidence in your timing abilities.

But don’t just listen to me. Check out how some of the greatest investors feel about trying to time the market.

Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient. – Warren Buffett

Whenever some analyst seems to know what he’s talking about, remember that pigs will fly before he’ll ever release a full list of his past forecasts, including the bloopers. – Jason Zweig

Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves. – Peter Lynch

Only liars manage to always be out during bad times and in during good times. – Bernard Baruch

Do you know what investing for the long run but listening to market news everyday is like? It’s like a man walking up a big hill with a yo-yo and keeping his eyes fixed on the yo-yo instead of the hill. – Alan Abelson

Do your future a favor and stay put. Sure the market may decline 15% this year. It might rise 20%. Or it might finish flat. Nobody knows. But 10,000 pundits will make predictions and some % will be right. And next year, when they’re on TV, they’ll talk about how they were right in 2013, which is of course why you need to listen to them now. No thanks. I’ll stick to the allocation that I determined based on my needed returns and willingness to accept risk. Hopefully you’ll choose to do the same.

Investing Doesn’t Need to be Complex

We all know that investing over time is the key to obtaining the wealth that we desire. Without investing in some form, dollars stuck under our mattress are eaten away by inflation, and we have to save at least $1 today for every $1 we want to spend in the future. By investing, we not only expect to outrun inflation, but we hope that $1 spent later costs us less than $1 saved today.

At the same time, on some level, you’ve probably realized that investing can be intimidating. I have friends who do not invest at all because they’ve become discouraged by recent returns or they believe that investing is too complex. How are you supposed to pick “the right investment”? What are you supposed to do when the market is tanking? And how should you allocate your investments?

Wall Street loves complexity because the standard investment vehicles are old and boring. Instruments like credit default swaps exist to make investing exciting for traders. But for those of us who live on Main Street, we would do best to throw all of these complex instruments out the window. If you can’t explain the type of investment to your grandma, then it’s too complex for your portfolio.

I strongly believe that the two factors that will have the largest impact on the eventual balance of your investment portfolio are:

  1. Investing more, sooner
  2. Keeping your investments simplified

I’ve already discussed the benefits of investing early (http://hackingthebank.com/investing-roth-ira-when-young) previously. The more that you can invest, and the sooner you can do so, the more you’ll end up with.  But I think that the simplification of investments is often ignored. A target date retirement fund can provide the ultimate simplification. But beyond that, I consider a “simplified investment portfolio” to be a portfolio consisting of a handful of index funds. For some great examples, check out the Bogleheads Wiki of Lazy Portfolios.

By investing in a handful of index funds with a proper asset allocation, you eliminate the risk of “picking the wrong stock.” You aren’t trying to speculate in gold or worrying about finding a tenant for your rental home. Just include a REIT in your portfolio as a real estate investment.

By keeping things simple with a handful of index funds you’ll be outperforming a majority of mutual fund managers. You also won’t have to worry at night that you’re invested in the wrong asset. For most of the year, you can relax and forget about your portfolio. Although I know a good deal about investing, I don’t watch the markets on a daily or even weekly basis, because I don’t worry about my portfolio at all. It’s simple and it’s sticking where it is. If you aren’t already investing in a handful of index funds, try it out and you will soon begin to appreciate simplicity.

Fixing Our Broken Retirement System with Opt-out Retirement Accounts

Social Insurance originally began in the late 1800s in Germany, and by the time the U.S. adopted its Social Security program in 1935, about 20 countries already had similar programs in effect. The basic idea behind social insurance is to work hard during able years to insure against the hazards of sickness, accident, involuntary unemployment, and old age. Whether someone wants to work or not, sometimes there are circumstances beyond one’s control that prohibit working. The system has worked and has served people well over the years. Looming fiscal crisis aside, the program has been successful.

However, while Social Security has been successful, it’s not enough. Most people are not able to delay gratification on their own. And I think we can all agree that having poor old people is not in any way a benefit to society. Having a bunch of poor old people will just cost us more money down the road. And if you don’t think that having poor old people is likely, just check out some of the statistics. Of people aged 50-65, more than 60% have less than $6,500 saved in their retirement accounts. At the age of 24, my fiance and I have as much saved for retirement as about 75% of people ages 50-65. Now, that is scary.

Investing for retirement is just like anything else in life. While some people can do it on their own, most people need a professional to handle it. Investing is like repairing a car. Many of us could learn to do it, but we don’t. Some people spend a lot of time research car repairs, reading car repair forums, and they repair their own cars well. It’s just like personal finance. Some people read personal finance blog and forums, and can invest for themselves. However, for most people, this clearly is not the case.

So, if low and middle-income earnings are not saving enough, what’s the solution? I think that automatically-enrolled accounts similar to IRAs are the answer. When employees begin working with an employer they should automatically be enrolled in a savings/investment account that would function much in the same was as a Roth IRA. Here are a few of my thoughts for this proposed account:

  1. The account would be opt-out. That means that all employees would be automatically enrolled. This would significantly boost the percentage of participants. Consider the organ donor program. In the U.S., you have a fill-out an additional paper at the DMV to become a donor, which results in about a 25% opting-in. In countries that utilize an opt-out system, such as Austria and Sweden, the percentage of people who have consented to donating organs is above 90%. An opt-out investment account would allow anybody who doesn’t want to participate to opt-out, it would just remove the barriers from opting-in, and thus result in more people saving for retirement.
  2. There are a lot of investment options out there to fit anybody’s financial profile. I think that it would be best to be conservative with the automatic investment and then allow investers to tweak their risk profile. A good starter investment would be a target-date retirement fund that starts with a higher-than-typical allocation to “safe investments”. For someone young, this might be 60% equity, 40% bonds. For someone aged 50, this might be 40% equity, 60% bonds. The key here is that the person is investing as opposed to not investing. That’s the first big step.
  3. I’d hazard to guess that most high income earners would rather self-direct their investments, and would choose to opt-out. However, low to middle-income earners are less likely to opt-out of the investment plan. And they’re the ones that need the most help saving for retirement.
  4. To further encourage use of this account and to offer similar benefits to an employer match, I think that 50% of any amount up to $3,000 should be a tax credit to lower and middle-income families. People with good jobs and employers who offer 401(k)s typically get employer matches, why should poor and middle-income people be excluded?

I’m not the only one that thinks this would work. Senators in California are currently working on SB 1234. Although I don’t think the bill is aggressive enough, it’s absolutely a step in the right direction. Employees who are not offered retirement accounts through their employers would be automatically enrolled in a low-fee, low-risk retirement savings plan. Unless employees opt-out, an automatic 3% of earnings would be contributed on their behalf. The funds would be pooled and likely managed by CalPERS. This makes sense, as it’s been proven that pooling funds decreases administration costs, and these reduced fees and result in a final nest egg about 30% greater than funds that are not pooled. The proposal is for a 50-50 stock-bond portfolio. I think this offers enough safety while still getting the upside from investing. If someone wants a different allocation, they can always opt-out. In all likelihood, the plan would offer some type of guaranteed return, which would be underwritten by insurers to insure that tax payers would not be footing the bill if actual returns were lower.

I think that California’s opt-out retirement plan is a huge step in the right direction and it’s something I’m excited about. Yes, it’s nerdy to get giddy about a bill proposing a new investment account. But that’s what I do. I think that, if implemented well, this could benefit a lot of people (those who participate, as well as those who do not) and this could lay the framework for a national policy involving out-out retirement accounts.