09 Nov Are You a Saver or an Investor?
Remember the Socratic aphorism “To know thyself is the beginning of wisdom”? Are you a saver or an investor?
Savers focus on the short run and earn low rates of interest in exchange for no risk of losing any principal. It is a mistake for a saver to invest because they will generally panic at exactly the wrong time and take losses just when they shouldn’t. It is fine to be a saver just as long as you don’t think you are an investor.
Investors ignore short-term volatility and generally are rewarded with higher returns. As investors we should expect that the risk asset portions of our portfolios may, on occasion, decline by one half (i.e. 1973 to 1974, 2000 to 2002, 2007 to 2009) and more frequently by smaller amounts.
Thoughts on Recent Stock Market Movements
October 9th to October 11th, the Dow Jones Industrial Average (DJIA) was down 1,378 points which translated to -5.21%. The media touts the points because it is more attention-getting, but it’s the percentages that are relevant.
The markets have been pretty calm for a long time and our memories tend to be short. That can make a rapid price decline seem even scarier and cause us to question our strategy. Is it time to panic and move to cash? While the drop in value is unnerving, the reality is that a 5%, 6% or even 7% drop isn’t particularly rare. Short term losses of that size or greater have occurred 42 times in the last 33 years. It wasn’t even the first time this year that very short term returns were that bad. February 1st to February 5th the DJIA was down -7.03%.
For really bad short term losses all we have to do is remember October 15th to October 19th 1987. The DJIA was down -24.57% over those few days. How would you react if that was the headline!
A drop in stock market prices can cause some folks to pull the panic lever. Successfully timing the market, however, requires being right twice. It’s hard enough to nail one correct call about the market’s direction. A handful of people might make the correct sell move before a big price drop. Very, very few folks also make a correct buy call on the other side.
Your first priority must be that your portfolio is appropriate for you emotionally – not just mathematically appropriate for your financial goals. We would rather you place your funds in safe investments at a bank than be in a portfolio that is inappropriate for you and causes stress or, even worse, panic. There are no perfect allocations nor perfect times to invest in risk assets. These things will only be known with the benefit of hindsight.
Despite what the self‑proclaimed “experts” on TV or in the press would have you believe, no one knows when those periods will happen or how long they will be sustained. The fact that so many professional investors are wrong on such a consistent basis should be a clear signal that humility should be your default position when thinking about trying to outsmart the markets. Investing is a game that’s won by those who use probabilities, not certainties. In other words, you need to figure out a portfolio allocation that works for you regardless of what happens to stock market prices.
- David Henderson, CFP