Stay Steady in the Wake of Market Waves

Physician's Money Digest, May 15 2004, Volume 11, Issue 9

Investor lesson:

Remember Dow 36,000 or Dow100,000? Those were the titles ofthe stock market's bestsellers inthe late 1990s. And many of us believed,or at least hoped, that the market wouldreturn to those levels again and we wouldearn riches. If there wasanything good about the market debacle,it's that it put us back in touch with reality.But the pendulum may have swung toofar in the opposite direction.

Many investors are now too afraid toinvest in stocks. I know because I'm oftenasked the question: Is this the right time toget into the stock market? This is almostalways the wrong question to ask and thewrong way to think about making investmentdecisions. There is overwhelming evidenceto show that essentially no one canreliably predict what the market will do inthe next week, month, year, or years.

Planning vs Timing

How should you decide on the righttime to get into the market? Make along-term plan and figure out how muchof your portfolio should be in stocks andhow much of your ongoing periodic savingsshould be in the market. Pick theright funds to invest in and then stick toyour plan, ignoring all market fluctuations.Don't ask anyone if it's the righttime to get into stocks. If you do, you'lllikely end up investing too little.

I'm not very optimistic about the stockmarket. I think it's still overvalued. Overthe next decade or two, the market isn'tgoing to do as well as it did in the '80s and'90s, and probably won't match its longtermreturn of around 10% per year. Ofcourse, none of us know for sure. There'sstill a good chance that stocks will do betterthan bonds and other alternatives.Most of us have to take the chance tomeet our long-term needs.

Phases of Evaluation

The market has three phases: dangerouslyovervalued, irrationally undervalued,and indefinite. Most of the time the marketis in the indefinite phase, which meansit's in a price range where no one can saydefinitively that it's overvalued, undervalued,about to take off, or crashing. Whenthe market is in this phase, as it is now,trying to make a judgment about whento get in is only going to lead to inactionand lost opportunity.

When the market is in the dangerouslyovervalued phase, it makes sense totake some money out of it or, at least,switch to safer funds and stop makingadditional investments. And when themarket is in its irrationally undervaluedphase, it's the perfect time for investorsto make an investment. Unfortunately,most of us do the opposite.

Keep in mind that there can be alarge opportunity cost of not investingenough in the stock market. We generallydon't recognize it because very few ofus keep track of how much money wemissed out on making by investing toolittle in the stock market. But it's as muchof a loss as when we invest in the wrongstocks at the wrong time.

Chandan Sengupta, author ofThe Only Proven Road toInvestment Success (John Wiley;2001) and Financial ModelingUsing Excel and VBA (JohnWiley; 2004), currently teachesfinance at the Fordham University GraduateSchool of Business and consults with individualson financial planning and investment management.He welcomes questions or comments