stock market record

Where’s the Stock Market Correction, Dude?

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As the Dow Jones Industrial Average and the S&P 500 touch new records, it’s time to review the state of the current rally.  The S&P 500 has skyrocketed about 195 percent since bottoming in 2009. That makes it the fourth-best bull market since 1928 in terms of both duration and magnitude, according to Bespoke Investment Group (via the WSJ). The market’s very strength is a bit worrisome to some traders because there has not been a 10 percent correction in over three years—as a frame of reference, corrections usually occur about every 18 months. We got close in 2012, but the last “official” one was in the summer of 2011, when the first debt ceiling crisis was raging. According to Yardeni Research, here are the recent corrections:

  • 2008-2009: -57% (510 days)
  • 2010: -16% (69 days)
  • 2011: -19% (154 days)
  • 2012: -9.9% (59 days)

Of course, just because a correction COULD be coming, does not mean you should bail out. There have been times when corrections are rare. The market avoided a 10 percent decline from 1990 to 1997 and from 2003 to 2007. The bulls point out that with the Federal Reserve keeping interest rates low, little sign of inflation and corporate earnings continuing to climb, the bull could still have room to run. The bears note that any given moment, stocks could see a dramatic reversal of fortune, at least in the short-term.

Luckily, you don’t have to time the ups and the downs of the market. In fact, if you simply adhere to your diversified portfolio, you will be able to ride out the highs and lows of the market. Of sure, there will be those who will say that it’s a "stock-picker’s market" or that a managed mutual fund will be better able to absorb downward shocks, but that’s rarely the case; and the pundits doling out that kind of advice usually have a financial incentive to get you to buy whatever it is they are selling.

The benefits of building a diversified portfolio of low cost index funds have been proven over time. Presuming that you have created an allocation according to your risk tolerance and personal goals and that you rebalance on a quarterly or semi-annual basis, there’s no need to change a thing when markets are reaching new highs or correcting.

Cash is King: How Nervous Investors Can Buy Stocks

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The Dow and S&P 500 stock indexes are making new highs and it's been more than five years since the markets bottomed out, but that's not enough to convince many investors to jump back in. According to new research by State Street, retail investors across the globe were holding an average of 40 percent of their assets in cash, up from 31 percent two years ago. The lowest levels of cash holdings were in India, at 26 percent; the highest was 57 percent in Japan. The US was in the middle at 36 percent, but that was an increase of 10 percentage points in just two years. This jump was equal across the age spectrum: Retirees or near retirees hold 43 percent; Baby Boomers have 41 percent; Gene X are at 38 percent and the Millenials are at 40 percent. After a once in a generation financial crisis and a severe recession, these investors, regardless of age, aren’t able to stomach the market's roller coaster ride.

So should the risk averse buy back into stocks? Murphy's Law would say that the day after they do finally pull the trigger, the long-awaited for correction will come storming into town. (The S&P 500 has gone nearly two years without a 10 percent correction – the last one occurred in the summer of 2011, when the S&P 500 plummeted by more than 17 percent after the debt-ceiling debacle).

That leaves many would-be stock investors with a tough choice: should they get back into stocks after markets have more than doubled or should they remain in their cash positions? If you are the kind of person who simply cannot handle the ups and downs of the stock market, then your inclination is probably to avoid stocks at all costs. But what if you kept your stock allocation to a level where they gyrations didn’t cause you to lose sleep? Maybe a stock allocation of 10 to 20 percent of your portfolio would allow you partially participate over time, but not get your hat handed to you if/when the bottom falls out.

However, if you realize that you are ready to build a long-term investment portfolio using stocks as part of your allocation, the big question is whether to invest your cash all at once (lump sum investing or LSI) or whether to use dollar cost averaging (DCA). Dollar cost averaging is the investment strategy that divides the available money into equal parts and then periodically, putting the money to work in a diversified portfolio over time. According to research from Vanguard, two-thirds of the time, investing a lump sum yields better returns than putting smaller, fixed dollars to work at regular intervals.

The mutual fund giant analyzed returns from 1926 to 2011 and found that a lump sum portfolio comprised of 60 percent stocks and 40 percent bonds over rolling 10-year investment periods beat dollar cost averaging by 2.3 percent. In other words, if you had invested $1 million all at once, it would have led to an average ending portfolio value of $2,450,264 after 10-years, versus DCA for the same portfolio, which would have been worth $2,395,824.

The $54,440 differential may be large enough for you to go for the lump sum without looking back. But what if the lump sum decision were to occur at the beginning of a terrible 10-year period for stocks? While lump sum may beat DCA two-thirds of the time, DCA still returns more one-third of the time.

If you are the kind of investor who is less concerned with the probability of earning and more worried about losing a big chunk of money immediately, you may want to stick to DCA. Vanguard’s study notes “risk-averse investors may be less concerned about averages than they are about worst-case scenarios, as well as the potential feelings of regret that would occur if a lump-sum investment were made immediately prior to a market decline.”

It is often said that there are only two emotions in investing: fear and greed. If you are tempted to add regret to that list, tread carefully as you make this decision.

Stock market highs: Should you buy?

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Dow 15,000! S&P 1600! The best start to a year for stocks since 1999! As the stock market continues its ascent, the most frequently asked question that I am receiving is:  “Should I buy or is a correction coming?” Recently on CNBC, Warren Buffett predicted that stocks will go "far higher" in the long run, so for those with 10 or 20 years to go before they need their money, there is no reason to alter your game plan – keep investing in a diversified portfolio. That said, stock indexes have gone 6 months without even a 5 percent correction – the last "classic" correction (defined as a 10 percent drop from the highs) occurred in the summer of 2011, when the S&P 500 plummeted by more than 17 percent after the debt-ceiling debacle.

So is a correction coming? Of course it is, but predicting when that will happen and trying to capitalize on it is a fool’s game. That leaves many would-be stock investors with a tough choice: should they get back into stocks after markets have more than doubled or should they remain in their cash and bond positions?

Part of the problem is that many investors are still stinging after the 54 percent drop from October 2007 to March 2009. As if that were not enough, confidence was shaken periodically during the recovery, whether from the 2010 "Flash Crash", the 2011 swoon or drops attributed to the European debt crisis. Those events may explain a recent Bankrate.com Financial Security Index, where a whopping 76 percent of respondents were just saying "no" to stocks. Economists call this “recency bias,” which means that we use our recent experience as a guide for what will happen in the future. So when stocks are soaring, we think markets will keep rising, but when the market plunges, we become convinced that it will never rise again.

But nearly 4 years since the end of the Great Recession, many investors are starting to ask whether it is safe to buy stocks. The answer is NO -- stocks are not a safe investment. If you are the kind of person who simply cannot handle the ups and downs of the stock market, then your inclination is probably to avoid stocks at all costs. But what if you kept your stock allocation to a level where they gyrations didn’t cause you to lose sleep? Maybe a stock allocation of 10 to 20 percent of your portfolio would allow you partially participate over time, but not get your hat handed to you if/when the bottom falls out.

However, if you realize that you are ready to build a long-term investment portfolio using stocks as part of your allocation, the big question is whether to invest your cash all at once (lump sum investing or LSI) or whether to use dollar cost averaging (DCA). Dollar cost averaging is the investment strategy that divides the available money into equal parts and then periodically, putting the money to work in a diversified portfolio over time. According to research from Vanguard, two-thirds of the time, investing a lump sum yields better returns than putting smaller, fixed dollars to work at regular intervals.

The mutual fund giant analyzed returns from 1926 to 2011 and found that a lump sum portfolio comprised of 60 percent stocks and 40 percent bonds over rolling 10-year investment periods beat dollar cost averaging by 2.3 percent. In other words, if you had invested $1 million all at once, it would have led to an average ending portfolio value of $2,450,264 after 10-years, versus DCA for the same portfolio, which would have been worth $2,395,824.

The $54,440 differential may be large enough for you to go for the lump sum without looking back. But what if the lump sum decision were to occur at the beginning of a terrible 10-year period for stocks? While lump sum may beat DCA two-thirds of the time, DCA still returns more one-third of the time.

If you are the kind of investor who is less concerned with the probability of earning and more worried about losing a big chunk of money immediately, you may want to stick to DCA. Vanguard’s study notes “risk-averse investors may be less concerned about averages than they are about worst-case scenarios, as well as the potential feelings of regret that would occur if a lump-sum investment were made immediately prior to a market decline.”

It is often said that there are only two emotions in investing: fear and greed. If you are tempted to add regret to that list, tread carefully as you make this decision.