Friday, December 12, 2014

As Stock and Oil Markets Tumble, Stay Calm and 'Don't Peek' ... This Too Shall Pass

This was a lousy week for stock market investors, and the Dow dropped more than 300 points Friday. But it was an even worse week for energy prices as the price per barrel of oil dropped by ~12% for the week and more than $2 Friday, hitting a closing price of $57.77 per barrel.

So it's fair to say that this was the week that was, and the appropriate question to ask is "Now what?

When markets tumble, our tendency is to do something and that usually means that we may panic and sell. That's the exact wrong thing to do

During market turmoil, sitting tight and doing nothing is the best 'action' for long term oriented individual investors. If anything, it's time to buy when stocks drop in price and are 'on sale.'

But if you're still inclined to do something and sitting tight or simply counting to 100 slowly doesn't work for you, then try this -- close your eyes --- don't peek. This too shall pass.

When markets tumble, be like Bogle -- 'Don't Peek' offers sound advice for individual investors during times of extreme market volatility and unrest:

"Will there be a Santa Claus rally this year? . . .

Importantly, this isn't just a game in which the clock has run out and managers get to start over. For retirement investors, a lost year really hurts. Compounding money in a risk-adjusted portfolio is the only reasonable way to build a truly reliable retirement. Sitting out one or two years with a low return creates real long-term pain. . . .

Risk-adjusted investing is an important concept, one that many people misunderstand. If you are going to be in the market for many years — and that's what retirement investors do — the goal isn't to grab a market-beating year. Rather, you should do nothing at all.

Common sense

To quote John Bogle, founder of the Vanguard Group and a longtime proponent of passive investing: "One of my favorite rules is 'Don't peek.' Don't let all the noise drown out your common sense and your wisdom. Just try not to pay that much attention, because it will have no effect whatsoever, categorically, on your lifetime investment returns."

The reason why you don't peek is risk. If you target a specific return, say, 8% annually, the next question you must ask yourself is, "How much risk can I withstand to reach for 9%?"

A young person just starting a new job might answer that question quite differently from a 60-year-old. Given the decades of investing ahead of a 22-year-old, a decline in the stock market of 20% or 30% isn't a disaster. In fact, it's an opportunity: Stocks are on sale! . . .

Nothing easier

The larger concern is continually underperforming the stock market, year after year. Just by using the Rule of 72, we know that a 10% return will double a portfolio in a little more than seven years (7.27 to be exact).

An active manager who returns 5% net of fees needs close to double the time to double your retirement balance (14.21 years). . . .

The answer isn't that complicated. Build a simple, low-cost portfolio . . . and rebalance . . . year in and year out. Nothing could be easier to do."

Summing Up

The week just ended was a rough one for short term oriented stock market traders.

For long term individual investors, however, it was only one 'down' week out of hundreds more 'up' weeks to come.

Thus, it's no time to panic. In fact, the continuing huge drop in the price of oil (it fell 12% this week alone) will make our U.S. economic recovery stronger as consumers will have more money to spend and businesses will incur lower costs.

And to top it off, a strong U.S. dollar will keep domestic inflation under control which will facilitate low interest rates well into the future, even as the U.S. economy continues to gain strength.

So if you're getting nervous about the short term moves in the stock market, just try not to peek.

That's Mr. Bogle's take, and it's mine as well.

Thanks. Bob.

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