How to Get Your Market Losses Back Now! (Read on)

Darwin — Fri, 02 Oct 2009 03:42:35 +0000

Now, that’s a disingenuous title for an article. But I see it everywhere following the 2008-2009 stock market crash – from prominent money mags at the bookstore to web investing outlets and blogger posts. And it sure is enticing to click through and read on. There’s a simple reason you can’t and won’t easily “get it back”. Investing returns are commensurate with risk! Over long periods of time, stock investors are rewarded with higher returns than bondholders, which reap higher returns than FDIC-protected savings accounts and so on. This is both logical and is also demonstrated historically (excluding when you cherry pick your timeframes like the lazy portfolio articles propagating the web). However, it is naive to think that by simply piling on more risk you’re guaranteed higher returns any time soon – especially after the US equities market has just rallied 50% in 6 months.

If it were that easy to achieve high returns with low risk, don’t you think everyone would be doing it? (Efficient Market Theory basics).

Let’s take a look at what it would take to “get it back” from the 2008-2009 market crash:

Consider an investor who was 100% US stocks at the peak and now they’re looking at a steaming pile of dung in their 401K account. They want to “get it back”. Looking at where SPY, the S&P500 ETF (see this list of all developed and emerging market ETFs) was at the peak in 2007 at around 160 and where it closed today at around 103, in order to get it back, you’d need to return to 160 PLUS make up for inflation adjusted time loss (i.e. over a two year period, you shouldn’t consider getting back to even the old value, but value plus inflation). Let’s be kind and say inflation averaged 2.5% per year. This roughly matches the current dividend yield of the S&P500, so they roughly offset each otherm (I knew someone would comment that those dividends are going to help bridge the divide – but at these yields, it would be generous to say they even match inflation; we’ll call it even).

Let’s say you’re giving yourself a year to “get it back” quickly which the title implies. That would mean SPY would need to be at 160 in a year which implies a return of another 55% on equities following one of the most spectacular rallies in stocks of the century. Fat chance. Don’t get me wrong, I’m virtually 100% equities in my long time horizon retirement portfolios. I do hope stocks continue their ascent. But I’m pragmatic enough to understand that with these higher expected returns comes increased volatility and no guarantees of steady positive returns.

Some of these articles purport to “spice up” your portfolio with even higher alpha instruments like Tech ETFs and emerging markets – and the really dangerous ones entice you to consider double and triple ETFs. Long term, an equity-heavy portfolio including international stocks is great (not the leveraged stuff over time!).

But what about the 58-year old reading that article?

They just lost $500,000 in their 401K and have to consider either:

a) not retiring next year as they’d planned for years

b) not funding their kids’ college tuition which they were expecting

c) “Getting it back”.

Would it be prudent for someone with a 1 year time horizon to be heeding the call to MORE risk now in an attempt to “get it back”? Double down?

To avoid any confusion, I am a proponent of stock investing. I own equities – plenty of them. My time horizon is multiple decades, not the next couple years. For my short-horizon traditional trading account, I employ a different approach with hedges, options, income instruments and more (see my recent portfolio trading update). However, I do caution against making any assumptions on where equities are going to be in the next year – especially if I’m going to need to withdraw that money for living expenses.

What are your thoughts? Is it responsible journalism to entice readers to “get it back quick”?

Darwin's Finance » IRA

How to Get Your Market Losses Back Now! (Read on)