Keep eye on investment goals, not market

Mutual funds

June 30, 1996|By NEWSDAY

On May 22, the Dow Jones industrial average hit 5,778. Was that the market top? If it was and you owned stocks, you missed it. The Dow is already down since then and you didn't get out in time. More likely, you bought into the decline instead of selling.

So what?

We bring this up now because there is a lot of talk that high stock valuations, the speculative rage for initial public offerings and the flood of money into stock mutual funds by individual investors all point to a market top.

Again, so what?

Professional market timers aside -- and their claims of success are sometimes suspect -- market timing by individual investors is a fool's game.

"We have tracked investor behavior for both load and no-load fund buyers and the studies show that historically, they buy at the top and sell at the bottom," said Robert Powell, editor of Mutual Fund Market News, published by Dalbar Inc., a Boston mutual fund research and publishing company.

That means many investors tend to lock in a loss.

Studies by Ibbotson Associates, a Chicago financial research and consulting organization, and others all say the same thing: Individual investors who try to time the market fail, as do many professional investors.

No predictions

In fact, at a Morningstar conference this month, Garrett Van Wagoner, who has attracted $1.07 billion to three small-cap funds since starting his own company in January, was asked whether he thought the market was at a top. "I can't predict the market and I am not going to try," he said.

If you know you can predict market highs and lows, quit your day job and get rich. But before you do, consider:

"The stock market tends to be a great home-run hitter," said Todd Jaycox, an Ibbotson consultant. "Big gains come in concentrated periods. The market will be average, below average, a little above average and then drive one out. If you are not in the market at that time, you have missed it."

Jaycox said that if you take away the top 35 months between 1925 and 1995 -- an average of about two weeks per year -- stocks underperformed Treasury bills in that period.

Ibbotson found that $1 invested in large-company stocks in 1925 was worth $1,114 in 1995 (including reinvested dividends), an average annual return of 10.54 percent.

But if you had missed the best 35 months in that period, that dollar was worth only $10.16 -- an average annual return of 3.37 percent.

A dollar invested in Treasury bills was worth more, $12.87.

For the 1975-1995 period, the average annual return for the S&P 500 was 14.59 percent.

Take away the top 15 months and the annual return plummets to 6.79 percent.

Granted, there are differences in market breakdowns. The 1987 crash and recovery occurred in a very short time.

The 1990 bear market was also short-lived.

That was when many investors, cognizant of 1987, began to learn that it is sometimes better to buy into a market decline, when prices are lower, than wait until the market recovers and prices are higher.

Not all bear markets are as mild as those two, however. The bear market that lasted from Jan. 11, 1973, to Oct. 3, 1974, was grisly. The Standard & Poor's 500 lost 48 percent of its value.

A recent study by T. Rowe Price looked at two hypothetical investors with $10,000 each, who invested when the market peaked in early 1973, just before the bear bit.

One stayed in stocks and continued to invest $100 a month; the other went into cash when the S&P dropped 10 percent.

After five years, the cash investor had $19,000, compared with the stay-the-course investor's $16,700. After 7 1/2 years, however, the stick-to-it investor pulled ahead.

In the shorter-lived 1987 bear market, when stocks dropped 33 percent in less than four months before rising, the stick-with-it investor pulled ahead much more quickly.

Those are academic studies that tend to look at worst-case scenarios: investing just before the market falls apart.

Real world

But the real world is different.

Take two investors. Each invested $20,000 in the same no-load mutual fund on Jan. 2, 1995. After a great 1995 and a good -- though volatile -- early 1996, those shares are worth $30,000.

Investor A suddenly notices that the market and his shares are down 10 percent, and now worth only $27,000. So he sells. But he has a $7,000 profit, and has to pay $1,960 in taxes at the 28 percent capital gains rate, leaving him with $25,040.

He puts that cash in a tax-exempt money market account that pays 3.6 percent a year for four months, earning 1.2 percent, or $300, while he rides out the market drop. So he has $25,340 to invest when the market goes back up.

Investor B leaves her fund investment alone.

The market drops 10 percent and she does nothing. Then the shares go down another 5 percent, bottoming there.

Her stock is now worth $25,500.

The market recovers and rises 10 percent before Investor A notices and is confident enough to go back in. He puts his $25,340 back into the same fund.

Investor B, whose shares have gone up that 10 percent, now has $28,050 in the fund. Investor B is an easy winner.

Those examples assume that the fund is no-load -- no upfront commission on share purchases. If Investor A had to pay a commission, his total would be lower. And if Investor B used dollar-cost averaging, putting $100 monthly into the account throughout the decline, she would be even further ahead.

"It is best just to disregard the market and focus on your behavior," Dalbar's Powell said.

That means remembering why you are investing, what your goals are -- be they retirement, college or a trip to Hong Kong.

It doesn't mean you have to stay in a fund forever.

It just means that you had a reason to invest in the first place, and it wasn't timing the market.

Pub Date: 6/30/96

Baltimore Sun Articles
|
|
|
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.