Tuesday, September 1, 2015

Global Markets Fall Hard ... The Decision to 'Buy the Dips' or Not When Stocks Are 'On Sale' Depends on Our Age and Circumstances ... Understanding 'Sequence Risk'

Global stocks are falling hard again today after more disappointing economic news from China. Some markets have fallen by ~4% and the U.S. market looks like it will open about 2% lower.

Global Shares Fall After China's Weak PMI Data has this morning update:

"Global stock markets tumbled Tuesday after weak manufacturing data in China fueled investors’ worries about the world’s second-largest economy. . . .

“International investors have become extremely concerned about the state of China’s real economy,” economists at UBS wrote in a note to clients, adding that some investors are fearful that the situation could still get worse.

The Stoxx Europe 600 fell 3.1% in early trade Tuesday. The Shanghai Composite fell nearly 5% early in the session before ending the day down 1.2%. Hong Kong’s Index fell 2.2% and Japan’s Nikkei lost 3.8%.
Futures contracts pointed to a 2.3% opening loss for the Dow Jones Industrial Average and a 2.4% fall for the S&P 500. Futures, however, don’t necessarily accurately reflect moves after the opening bell.

Stock indexes around the world suffered their biggest monthly losses in years in August. The Stoxx Europe 600 had its largest one-month percentage decline since August 2011. The Dow fell 6.6%, its biggest monthly percentage decline since May 2010. The Shanghai Composite fell 12.5%, notching its third straight month of declines."
So what does all this mean for individual investors? What should we do? Should we buy the dips or should we sell? But what if we do decide to sell? How will we know when to get back in the game? The short answer is this --- we won't know when. That's why long term individual investors stay the course, even when times get tough.

Accordingly, when contemplating either buying or selling, we first need to consider 'sequence risk.' While still young, it's a good idea to buy 'on sale' at low prices, but as we age, the good idea is to sell when prices are high.

So here's the individual investor's recommended game plan: when young buy more when stocks are 'on sale;' and wait to sell at 'full price' as an oldster. Getting the best of both worlds is the plan.

Buying the Dips Doesn't Work for Everyone has this solid advice for individual investors:

"As the Dow Jones Industrial Average has lurched hundreds of points up or down . . . in the past few days, investors have received one constant message: Buy on the dips. If stocks go down further, buy more. . . .

But don’t let other people’s bluster fool you. If you’re young, the sudden popularity of the idea that market declines are manna from heaven should make you nervous, even though it’s right. If you’re in or near retirement, it should scare you, because it’s wrong.

As Warren Buffett wrote in 1997, stocks are like hamburgers: If you’re going to be purchasing them regularly for years to come, you shouldn’t want them to go up in price. Any drop in the stock market, so long as you have the gumption to take advantage of it by buying more, is good for anyone who is still saving and investing for the future.

On the other hand, if you are at or near the age when you need to make regular withdrawals from your portfolio to fund your retirement, a fall in the stock market can be catastrophic, and you need to decrease – not increase – your exposure to it.

That’s not merely because stocks can take years to recover from losses and you have fewer years left as you age. The problem is what retirement researchers call “sequence risk.” The order in which stocks earn good or bad returns can matter — a lot.

A 30-year period in which the stock market drops at the beginning and rises toward the end can have the identical average annual rate of return as a three-decade period in which stocks rise at the beginning and fall at the end. But the results will be drastically different.

Let’s say you’re in your 20s. At this point, your 401(k) and similar accounts hold only a small fraction of the total retirement savings you’ll accumulate over your working lifetime. Meanwhile, the money you can add each month while stocks are down is sizeable enough, as a proportion of your total assets, to add a noticeable boost to your wealth if stocks eventually recover.

Now imagine that you’re in your late 50s. You’ve already amassed nearly all of your lifetime retirement savings. And the amount of money you can use to buy more stocks at bargain prices is a pittance in comparison to what you will lose on the stocks you already own.

The 20-year zone centered on the age of retirement — from around age 55 to 75 — is when the greatest amount of your capital is likely to be exposed to sequence risk . . . .

The final straw: Once you do retire, you might have to fund your expenses at least partly by taking money out of your stock portfolio. If those withdrawals coincide with falls in the stock market, you are effectively “selling on the dips and locking in all the losses,” says Wade Pfau, a professor at the American College of Financial Services in Bryn Mawr, Pa., who studies retirement income. “Even if the market recovers, your portfolio can’t recover at nearly the same rate, because you’ve already taken that money out of stocks, and it’s gone forever.”. . . The more cash you hold, the less you will need to fund your retirement spending by having to sell stocks when stocks are down. . . .

No single approach can solve the problems of sequence risk all by itself, say retirement analysts. Taking more than one of these measures will help, but probably the most powerful way to protect yourself is by being prudent. As you approach or move into retirement, remember that the advice to buy more stocks every time they drop probably doesn’t apply to you anymore."

Summing Up

When investing for the long haul, time is very much on our side when we are still relatively young.

So let's encourage our young friends to take full advantage of this time factor. By so doing, the young can learn early not to overreact to short term gyrations in the market since they don't yet have lots of their 'skin in the game,' aka much money saved and invested.

Then later when they have lots of money, they won't overreact and sell when market turmoil strikes unexpectedly. Instead they'll consider buying more --- like now.

When I began investing in stocks with a few paycheck dollars in 1969, the Dow was ~1,000. It promptly fell dramatically and didn't regain the ~1,000 level until almost fifteen years later in the early 1980's. Now it's over 16,000, and that doesn't count all the cash dividends received along the way.

The good news for me (in hindsight, of course) was that for many years as a novice individual investor, I was able to buy low.  More importantly, I learned to stay in the game, to be patient and to focus on the long term.

So here's my time tested and experienced based simple advice to the young: get an education, avoid onerous debt, get a good job, invest in blue chip stocks, contribute regularly, and don't get discouraged when stock prices are 'on sale.' Stay in the game.

And for my fellow oldsters, take some time to internalize the meaning of 'sequence risk' and then be guided accordingly. The inescapable and undeniable fact is that the amount of time oldsters have to recover from market falls is much shorter now than when we were younger.

That's my take.

Thanks. Bob.

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