Tuesday, July 30, 2013

Stock market always goes up over the long run? Define long run.

My passion for following the financial markets had a basic start.  For many years, my thinking on investing was limited to this idea: picking individual stocks is difficult.  Not a bad start considering that almost all fund managers cannot beat the S&P 500 and there's a good argument to be made that those who do beat the overall market in the long run are simply lucky (except Warren Buffett and a few other people: they seem to have real and rare skill).

Then I discovered low-cost index funds.  Again, not a bad idea.  Low-cost index funds are endorsed by Buffett and other master investors as most appropriate for most people. 

But then I learned about how the stock market alternates between long periods of boom and long periods of bust (or going sideways).  And my awareness of how the stock market can go down or sideways for 20 years or more (a generation) led me to dig deep into different investment approaches.  What can an investor do during generation-long periods of declining stock prices?

I do believe that index funds are the most appropriate investment vehicle for almost all of us.  I also think long-running bear markets (a bear market is when the overall direction of the stock market is down) pose a difficult challenge to index funds.

The admirable John Bogle, founder of Vanguard and the first index mutual fund available to the public, might say index fund investors should hold on through thick and thin and for the long run.  But what if the long run is 20-30 years of a declining and highly volatile stock market?  Even if we believe America will always bounce back from difficulty, how many of us can keep that faith in the stock market as we watch our 401(k) account tank?

Consider just the most recent 15 years or so.  The stock market is essentially flat since the technology bubble's peak in 2000.  And if I had invested in the market in 1999 or 2000, I would be about even if I held on to my index fund shares through two gut-wrenching stock market crashes (dot-com and housing crashes). 

So then do you try to find a good stock picker who can identify stocks that will go up when the overall market is going down?  But remember how difficult it is to pick individual stocks: almost nobody can do it consistently as Buffett has done.  How about trading stocks?  While I personally feel that trading is a compelling way to navigate the markets with a portion of my portfolio, I feel that trading doesn't seem like a good idea for most people.  Stay out of the market?  But how do we know when to get out of the market?  Of course we can avoid the stock market.  There is no law that says we have to invest in the stock market. 

For those who want to be in stocks, it seems Mr. Bogle's advice can be sound.  If we can follow it.

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