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By Jane Bryant Quinn
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No god-given tablet says that investing should be made easy. In the years running up to the 2000 market peak, any dummy could make money in stocks, and did. But history is pocked with long periods when it's tough to scratch out a capital gain. Like now. As a result, investors are losing faith in the one thing they thought they'd learned: riches await, if you buy and hold stocks.
But trusting the long term makes no sense when we don't know anything about the future, argues economist Peter Bernstein, author of "Against the Gods: The Remarkable Story of Risk," a splendid book about how we measure investment risk.
U.S. stocks have decisively outperformed bonds for a century or two. But when everyone seizes on the same strategy, it doesn't work as well. Over the past 10 and 20 years, bonds yielded fantastic returns--sometimes better than stocks. Stocks, for their part, sometimes zigzag sideways--as during 1966 to 1982, when the Dow Jones industrial average cycled between about 650 and 1000. Would you be content to hold stocks for 16 years, earning nothing? No way--you'd aim to sell when prices approached 1000 and buy when they dropped near 650. You'd be seeking the right moment to invest.
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Bernstein thinks market timing will come into fashion again. "Throw out the old rulebook," he says. Forget staying 100 percent in stocks, even if you have a long holding period. Forget fixed allocations between stocks and bonds. "We have no choice but to be shorter-term in our outlook," switching our money around. Easy? No. Essential? Yes, in Bernstein's view.
He bases his case on the market's current economics. When stocks were beating the pants off bonds, their average dividend yield came to 4 percent. In fact, increases in price account for only 2.1 percent of the market's real, 7 percent long-term return. All the rest comes from reinvested dividends. Today, however, stock-dividend yields are down by half. To equal past returns, the rate of price appreciation would have to more than double. Fat chance.
A recent study by economists Lacy Hunt and David Hoisington found that bonds' magic moments arrive when inflation drops, stocks boast a rich price-earnings ratio and bond yields are high compared with stocks. Like now. All this suggests a rough time for the church of buy-and-hold.
The trouble is, most people--amateurs and professionals--are lousy market timers. Take the investment newsletters. Mark Hulbert, whose Hulbert Financial Digest tracks newsletter performance, found that market timing plus active stock-picking by mutual-fund managers reduced investment performance by 2.1 percentage points a year over the past 10 years. Why do investors pay gurus to lose?
There are other ways of protecting yourself in today's new markets:
Rebalancing. You decide what percentage of your money to keep in well-diversified no-load funds for bonds, big stocks, small stocks and so on. If one of these assets outperforms, take some profits and reinvest them in a lagging fund. This isn't exactly market timing. But it helps you to sell high and buy low. Ask your own fund if it will rebalance your money automatically.
Personal trading rules. If you own individual stocks, sell if they drop 15 percent. Or sell if they hit a 52-week low. With that rule, you wouldn't have held techs all the way down, says CyberTrader's Ken Tower.
Market-timing newsletters and Web sites. Two with consistent records are NoLoad Fund*X, which switches you from fund to fund, and the model stock portfolios from the Value Line Investment Survey, Hulbert says.
Polymath funds. Consider a manager who doesn't stick to a single style, but moves in any direction that seems wise. Morningstar calls them "hybrids" or "blends." Two such: Vanguard Wellington and the socially conscious Parnassus Fund.
A hitch for market timers is taxes. When you hold a stock or fund for a year or less, profits are taxed as regular income, not capital gains. So timing is best done in tax-deferred accounts.
Statistically, buy-and-hold is compelling, Hulbert says. But few people actually hold a fund for 20 years, and usually sell when the market dives. Hulbert doesn't practice market timing in his own account. He diversifies across different types of assets (cash, bonds, various types of mutual funds) and adds money every month. At most, he changes the asset mix.
That's the way to buy and hold. Don't do it with individual stocks, says Larry Swedroe, author of "Rational Investing in Irrational Times." That's speculating, not investing. You're taking the risk that your particular company will blow up. A long-term portfolio should contain diversified, no-load mutual funds, covering large and small stocks, international stocks, real-estate funds and bonds.
You cannot reliably predict when the market will rise or fall. The fact that you clamor to know the future is probably the main reason why so much nonsense is written about the stock market, says economist Andrew Smithers, coauthor of "Valuing Wall Street." Like now.
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