As the economy worsens and unemployment continues to rise, many people who have stayed invested may be asking themselves if they made a mistake by not selling out and remaining in cash.Conversely, those who have cashed out and have been sitting on the sidelines are patting themselves on the back for a job well done. However, at some point they will need to figure out how and when to get back in the market.
Certainly those people who have stayed invested are faced with a more difficult decision as to what to do now. Those in cash can sit on the sidelines, and when things begin to get better, they will jump back in to the market in plenty of time to enjoy the upswing.
SOUNDS EASY, RIGHT?
Not so fast. How do people know when things are better? Common answers range from scientific responses, such as, "When GDP growth is positive again" or "When unemployment claims fall," to unscientific responses, including "reading it or watching it on the television" and "I'll know when I know."
The problem with all these answers, and those in between, is that they disregard the main point, which is that no one knows when it's right to get back in, even the experts.
DON'T BELIEVE ME?
Next time you're in your car, spend about an hour listening to the so-called experts on different radio stations. I assure you that you will hear many differing opinions on what is going to happen next. Try the financial stations on TV - again, differing opinions.
Why would such news outlets present differing opinions? Why not find the one expert who knows what will happen next and put him on all day? Wouldn't it be great for ratings if they could boast that they have the expert who got it right? Well, they don't do that because, like the mythical unicorn, that expert does not exist.
What about relying on statistics such as GDP and unemployment to signify when to get back into the stock market?
The problem with those indicators is that they are not typically leading indicators of the economy. In other words, by the time final GDP growth (or decline) is reported, it is generally almost three months after the previous quarter ended. At its committee meeting in November, the National Bureau of Economic Research, a private, nonprofit, non-partisan research organization, reported that the economy has been in a recession since Dec. 31, 2007.
That it took them 11 months after the fact to announce the recession would seem to indicate that for the average investor it would be pretty difficult to predict that ahead of time.
Unemployment figures are reported monthly for the month ended. However, rising unemployment rates don't predict a recession. When unemployment rates rise, the economy is already in a recession. Unemployment rates sometimes rise even after the economy recovers.
Finally, making all of this even more problematic is the fact that the stock market, unlike GDP, unemployment, or the TV and radio talk shows, is a leading indicator of the economy.
On Oct. 9, 2007, the S&P 500 hit an all-time high. As we have seen above, this was two months prior to the beginning of this most recent recession. The last recession prior to this one, as measured by the NBER, began in March 2001. On March 12, 2001, the S&P 500 closed at 1,180. On Sept. 21, 2001, the S&P 500 bottomed out at 965. This was about a month and a half before the economy came out of the recession in November 2001.
A comparison of unemployment and the market yields similar results. Unemployment continued to rise after November 2001 (when the NBER said the recession had ended), peaking at 6.3 percent in June 2003. However, the stock market bottomed out well before that on Oct. 9, 2002, at 777, and rose from there, even as unemployment continued to rise.
So given all of the above, what should the investor do who has stayed committed to equities during this period of time, and when should the cash investor come back in to the market?
For the investor who has stayed invested, the answer is to remain invested. Given the inability to predict when this will end, the only way to ensure that any losses in their account will be temporary is to remain invested. Selling now would only make those losses permanent.
For the investor who is still in cash, getting back into the market all at once may be too much to handle, given the market's instability. A good compromise would be to begin dollar-cost averaging back into the market over a period of time. Dollar-cost averaging protects the investor against a falling stock market, since no one's entire portfolio is invested in the market at once.
However, investing systematically over a period of time allows the participation of some of a portfolio if the market does increase over that period. Determining the time period to dollar-cost average depends upon the investor's risk tolerance. Again, given the market's fluctuations, dollar-cost averaging over the next year should give the cash investor enough time to get back in the market while protecting against a major decline in their portfolio due to any sharp pullback in the market.
While investors sitting on the sidelines may be laughing now, in the end it's those who have chosen to stay invested who may very well be the ones laughing all the way to the bank.
Which bank that will be is another story.
Howard Hook, CPA, CFP, is a financial planner with wealth management firm Access Wealth Planning in Roseland and Princeton, N.J. Reach him at firstname.lastname@example.org.
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