for the long run, own stocks; skip bonds and cash

Many investment "experts" are advising their clients to temporarily hold extra cash in lieu of stocks and bonds as part of a "defensive" investment move. Their concerns revolve around the possibility of both stocks and bonds going down in the near term. (The New Cash Hoarders: Smart or Not-So-Smart?) My view is that it's at least as likely that the market will go up as down in the near term. In fact, during this very week when the article was published, the market has rallied explosively to the upside. But that's not the issue, because it could just as easily have gone down this week.

As one old saying goes, predictions are dangerous, particularly those about the future.

But first, let's review a little background concerning bonds as an appropriate investment. My belief is that bonds will be a poor investment and not be a suitable investment vehicle for many years to come. That's due to the present abnormally low level of interest rates. From this low base, rates will probably increase substantially over time, and since interest rates move in the opposite direction of bond prices, the price of bonds will decrease. Thus, the conclusion is pretty simple for long term investors. Stay away from bonds, both now and for the foreseeable future.

Where I really part ways with the "experts" concerns their advice to hold lots of cash now (and which cash would otherwise be invested in long term assets). This temporary market timing approach makes no sense for the long haul, and an in-and-out trader mentality is inappropriate for long term investors. Besides, market timing is usually harmful to a portfolio's performance in the short term as well. Cash hoarding is not good advice for one very specific reason; nobody knows the direction the market is going to take in the short term.

But even if this time our expert had gotten lucky and guessed accurately that the market was going to decline, that still would only have been one half of the story. In addition to having guesstimated correctly to sell and raise cash before the decline, he also would have to have known when to have bought again. In other words, it's not enough to guess accurately once. He would have had to have done it twice in a row.

To restate the obvious, nobody knows what the market will do in the short term, or even the medium term, for that matter. Price volatility is quite common, and the daily "noise" of the market causes many people to be squeamish, if not intimidated. As a result, people are easily persuaded to either stay away from stock investing entirely or to trust their money to the judgment of an investment "pro". In my view, both these choices are poor ones.

If our investing horizon is long and our investment goals are established, let's just buy a basket of strong and well managed companies at good prices, monitor the operating performance of the companies owned, hold the stocks for the long haul, then intend to just sit back and take advantage of the magic of compounding over time. In this regard, the real expert investor Warren Buffett says that his preferred holding period for a stock is forever.

With respect to the above referenced cash hoarding article, it warns market timers as follows, "..... the new cash hoarders could miss out on gains when the market recovers. Consider: Investors who stayed invested in the S&P 500 Index over the past 20 years had an average gain of 9.1% a year, roughly 5 percentage points higher than the average investor who moved in and out of funds ......"

That pretty much sums it up. During the past twenty years, the buy-and-hold individual investor beat the market timer by an enormous amount. For example, $100 invested for the 20 years at 9.1% annually would have grown to $570. That same $100 growing at 4.1% (5% less than the buy-and-hold approach) for the in-and-out investor would have been worth $223 at the end of the two decades. $570 is greater than $223. A no brainer.

Let's face the facts. Most investment pros simply don't beat the performance of the general market indices over time. They don't even come close, all things considered. And what are some of the things that need to be considered, in addition to the general market performance? Well, let's never forget the negative impact of those "intermediary costs" to the investor such as commissions, fees (disclosed and hidden), transaction costs and taxes (where applicable).

In fact, it's not all that uncommon for a fund to report double digit increases in fund performance over a period of time while the average investor in that same fund loses money. That's because our emotions often cause us to act both often and irrationally. We buy high and sell low, become trigger happy and lose our money doing so, in other words.

The basic lesson to be learned is simply that it's silly and expensive for individuals to try to time the market. Why then do we continue to do just that? In part, the answer is that it's caused by the "professionals" who make their living by advising (and charging) the individual investors to trade often. Sad but true.

Now none of this is meant to suggest that we should not engage responsible people that we trust to help us invest. And for that "value added" service we should expect to pay a reasonable fee. It also means we should assure ourselves that the people we've retained to help us possess both the required expertise and a low cost approach to fees.

Because of intermediary costs, we're recommending that most people, at least initially, put their money in a low cost passive S&P 500 Index fund.

To repeat, intermediary costs reduce the amount of money earned on our investment. If the general market increases by 9% and the intermediary costs are 4%, then we only earn a net of 5% annually.

Stated another way, that 4% (9-5) difference means this: a 4% lower annual intermediary cost would result in a doubling of our investment after 18 years, in addition to the general market's investment return. Over 36 years (remember the rule of 72), that's a 4-fer effect, again excluding market returns. In an investing career of 36 years, we therefore end up with four times more money than taking the high touch, high cost, "expert" route.

In addition to the rule of 72, we also need to become more familiar with the concept of dollar cost averaging, churning, reversion to mean, valuation, trendlines, sector investing and such. We'll try to address all these issues and more in future writings.

To recap, there are only two times we should be concerned about the price of any stock --- when we buy it and when we sell it. If we intend to own the stock for several decades, we should trust the historical record and have confidence that the stock's price will appreciate over time at a rate which is comfortably greater than inflation. And that it's very likely that the stock price will increase even more rapidly than that.

At a later date or dates, we'll go deeper into the reasoning behind our unconventional and perhaps controversial recommendation for owning all stocks and no bonds. Suffice it to say for now that we firmly believe this approach, when combined with a focus on low intermediary costs, is the absolute right thing to do.

So for now, think all stocks with low costs coupled with the "magic" of the rule of 72.

Thanks. Bob.