Missing the Stock Run-up

Long ago (2000), my significant other got out of the stock market at just the right time. It was the wrong reason (she was concerned about Y2K, but it happened at the right time. Fortunate her.

For people who got out of the stock market in early 2009, and stayed out, unlucky them. Investment guru Barry Ritholtz shines a light on the problem:

So, you missed the big market rally. U.S. stocks have moved nearly 150 percent since the March 2009 lows, and you sat out most of those gains.

I’ve heard all the reasons: Maybe you jumped out of stocks in 2008 and stayed out. Perhaps you were in at the lows, but after the first 20 percent advance, you lost your nerve. The Flash Crash of May 2010 sent you running for cover? Or was it the 19 percent drop before QE2 was announced in August 2010? ...

And Barry offers solutions:

1) Acknowledge the error: First thing you need to do is own up to the mistake. No, this wasn’t the fault of the Fed or President Obama or some algorithm trading server somewhere in New Jersey. It is your portfolio, your retirement account, your future. You cannot fix it if you are still blaming everyone else. ...

2) Stop beating yourself up: This market has confounded amateurs and pros alike. Unless you came to an early understanding of how the Fed has been driving liquidity and, therefore, equities, it was easy to miss. ...

3) Change your sources: Most of the people I speak with who have missed this huge move have been consuming a diet of doom and gloom. ... Constantly reading about hyperinflation and the collapse of the dollar and the end of the United States as a world power and the student loan crisis and omigod Obamacare is going to crush America and the Chinese are taking over the world and . . . STOP! Right now. It is recession porn. ...

4) Look at the rest of your process: How do you make investment decisions? Are you careening from stock pick to stock pick, after watching too much financial TV? Do you even have a process?

Whatever it is you have been doing obviously has not been working. It is likely you are missing two important components of an investment plan: the plan itself and an error-correction method that allows you to reverse the inevitable mistakes that will occur.

5) Create an asset-allocation model: Of course, if you missed the entire rally, you don’t have much of a plan. You need a full-blown investment strategy.

Own five to nine broad indexes, typically in exchange-traded funds (ETFs) or low-cost mutual funds. In decreasing amounts (35 percent, 30 percent, 20 percent, 5 percent), you should own: large caps, small caps, emerging markets, global equities, technology, real estate, bonds (corporates, Treasurys, munis) and commodity indices.

6) Deploy your capital: You need to make your capital work for you, not sit in cash. Deploy this capital based on time, on market levels, on a model or any objective metric, just so long as it is not driven by your gut instinct. ...

7) Dollar-cost average: You can allow time to work in your favor by deploying your capital in 12 monthly (or four quarterly) equal amounts. This avoids the classic market timing issue, and allows any market volatility to work in your favor. ...

8) Rebalance regularly: You now have a simple model with various asset classes held in different weightings (35 percent to 5 percent). Over time, some will do better or worse than others. Eventually, the model drifts. The process of returning the portfolio to its original percentage weightings is called rebalancing. ...

9) Be diversified: We own stocks and bonds and real estate and commodities (pretty much in that order). When one market or asset class is falling, others tend to go in the opposite direction. ... A balanced portfolio approach tends to underperform markets on the way up but suffer much less on the way down. ...

10) Understand your time line: People have a foolish tendency to lose sight of the long term in the midst of the day-to-day noise. Most of you have an investing timeline between 10 to 40 years. (If you plan to start withdrawing money to live on in 10 years or less, you will need to be more conservative).

I don't agree with everything above (you can invest the market quite nicely in the classic Three-Fund Portfolio), but Mr. R.'s points are largely on target: Invest widely on a regular basis, and take only as much risk as you need to. All the rest is flapdoodle.