The sensible way to approach the stock market
For a brief moment, the stock market — measured by the S&P 500 index of America’s largest stocks — recently exceeded its 2020 high by 0.1%. The techheavy Nasdaq-100 index briefly reached an all-time high over 11,000. Given market volatility, as you read this it could be lower, or even higher. But one thing is sure: In no way is the economy in better shape than it was in January before the COVID-19 pandemic started, and when most previous records were set.
Why is the stock market soaring amid double-digit unemployment, renewed business closings and uncertain corporate earnings? Pundits give simple answers.
The stock market is fueled by money — and the Fed has created a seemingly unlimited supply of liquidity to prop up the financial world. Much of that money is flowing into stocks. Also, the market is always looking beyond current economic conditions and earnings to a future time when momentum is regained.
But is the market correct in its judgment? Of course it is. The market is ALWAYS right.
The stock market is the place where investors agree to disagree. At any moment, a stock price is a perfect compromise: It is the price at which a knowledgeable buyer decides to make a purchase at the very same price a knowledgeable seller decides to get out. Thus, the stock market is always right — in the moment.
But how can intelligent, knowledgeable people agree on a price and yet disagree on future direction — all at the same time? That depends on your time horizon and risk tolerance and investment goals.
A day-trader might have a very shortterm time horizon, perhaps only a matter of hours. Even if she thinks the market is going much higher, it could be time to take short-term profits. A long-term investor might understand there has never been a losing 20-year period for the S&P 500. But that investor is now older and might need to withdraw money for retirement living within the next 10 years.
Each has a different reason to sell now. But other investors with differing market opinions or time horizons might think it is a perfect time to buy. They think the sellers at this price are making a foolish mistake. Only time will tell.
It’s tempting to believe that some expert money managers just know the “secret” to beating the markets. But the newly released S&P Dow Jones Indices Persistence Scorecard blows that idea out of the water! It says that over the past 20 years (May 2000 to May 2020), an investor in an actively managed fund had a roughly 90% chance of being outperformed by the corresponding S&P DJI benchmark index.
Or put it this way: Investors in funds managed by professional stock-pickers paid a lot of money in fees for only a 10% chance of beating the relevant index benchmark.
How much money did index buyers save? S&P DJI estimates it was a saving of $320 billion in fees between 1996 and 2019. And with management fees of index funds dropping to mere pennies, the discrepancies will grow.
The Persistence Scorecard compares only the survivors of the turbulent 21st century. During the last 20 years, nearly two-thirds of actively managed funds were merged or liquidated. And the report has consistently shown that even the top funds in one measurement period are unlikely to retain their ranking in the next. Or, as they say in the industry, past performance is no guarantee of future results.
The only sensible way to approach the stock market is to make a calm assessment of your own time horizons and your own tolerance for losses. Then buy low-cost funds and stick with them to avoid being whipsawed by market moves that are built on emotions. Over the long run (if you have the long run), that’s the way to come out ahead. And that’s The Savage Truth.
Terry Savage is a registered investment adviser and the author of four best-selling books, including “The Savage Truth on Money.” She responds to questions on her blog at TerrySavage.com.