Do you change your investment strategy in a falling market?

I read with dismay the following from an “investment professional” in yesterday’s Washington Post:

Now is not the time to drink the “buy and hold” investment strategy Kool-Aid. Be conservative, limit your risk–and sleep well knowing your investment principal is not going to continue to decline.

lose money in falling market

The comment was in response to the following hypothetical question: “If I don’t want to be in stocks right now, what should I do with my investment money?” This investment adviser went on to recommend a portfolio comprised of 80% TIPS and 20% gold. Here’s why he’s dead wrong.

We tend to be afraid of the wrong things. We’re afraid to fly, for example, even though it’s one of the safest means of transport available. Short term losses in the stock market are another fear that’s misplaced. Our real fear should be not having enough saved to live on during retirement. A portfolio of 80% TIPS and 20% gold probably won’t lose us money, but neither would a portfolio “invested” entirely in a savings account. The problem is most of us won’t have enough money at retirement if we follow this advice.

Fear of short-term losses in the stock market causes many of us to do just what this investment adviser is suggesting–head for the exits. The result is that we sell in a falling market out of fear, and buy back in during a rising market. This is a recipe for significant stock market losses. It is exactly, 100% what we should never do. As they say, if “buy-and-hold” investing is good enough for Buffett, it’s good enough for me.

Your asset allocation should be well diversified and designed to meet your financial goals. It should also be tailored to your risk tolerance (or even better, your risk tolerance should be tailored to your financial goals, but I digress). If you’ve designed a solid portfolio of equities and bonds, then you should expect to lose money over certain periods of time. What is happening in the market today should not surprise or shock you. And in the long run, it makes for a better time to buy stocks. The performance of your investments depends largely on what you do during a falling market. Here’s the advice I follow during a bad market: Don’t just do something, stand there! It works wonders.

To give the Washington Post a fair shake, I should add that it sought the advice of three financial professionals, not just one. And the third guy got it right, in my opinion. His name is David G. Speck, who is a managing director of investments at Speck-Caudron Investment Group of Wachovia Securities in Alexandria, Virginia. I don’t know Mr. Speck; never heard of him before yesterday. But he’s clearly tasted the Kool-Aid the first guy told us to avoid, and I’m sure his clients are glad he did. Here’s what he had to say:

In an uncertain market, the best thing you can do is avoid any strategy that is predicated on hoping you guess right on stock movements. Over time, the market always goes up, and the only way to participate is by being invested at a level that does not cause you to lose sleep.

A reasonable strategy is to buy several well-managed stock mutual funds that cover a broad base — domestic large-, mid- and small-cap stocks, blue-chip dividend stocks, and global/foreign.

But keep some of your money in short-term cash instruments — CDs, traditional money markets, Treasury bills. You’ll get low interest, but you also get the flexibility to invest back in the market.

Most important, don’t panic or make panicky decisions. Successful investors are balanced and diversified, invest long-term and typically hold on to investments that are well-managed even when values fluctuate.

I raise my mug of Kool-Aid to Mr. Speck for excellent investing advice.

Topics: Investing

16 Responses to “Do you change your investment strategy in a falling market?”

  1. Richard

    Investing in gold WILL lose you lots of money if you buy it 9 months after the stock market starts going down and sell it once you’re convinced a new bull market is under way. It seems like the only kind of market timing that can work reliably is perfectly wrong timing based on what’s already happened.

  2. Mo Money

    Studies have shown that if you don’t time the market perfectly (and nobody has ever done that) you will miss out on the rebound. Only missing 2 or 3 days out of 2000 and you will not have the gain.

  3. Unless you are in retirement and have to draw down your investments, bear markets should make you happy, not upset. Here’s why.

    Although we all tend to think of our retirement in terms of dollars, it’s really shares. Shares of stocks that you own, marked to the current price in terms of dollars. What should be your goal when investing? To buy as many shares as possible at the cheapest price possible. Therefore, when the stock market goes down, it gives you (usually through your 401K) a golden opportunity to purchase a lot of shares on the cheap.

    When the market comes back, you will end up owning a lot more shares than you would have had it never gone down. At the end of the day you will be MUCH better off by continuing to invest in index funds through your 401K through a bear market than by investing in cash in a bear market.

  4. It all depends on what stocks you own. If you own stocks in the financial or construction or housing sectors, then I would sell as soon as possible. If you own stocks in energy or oil or commodities, I would hold on to them and consider buying more of them. Don’t panic, but do take a serious look at your portfolio.

    The ‘old economy’ that was bases on consumer spending is gone and the ‘new economy’ with a weakening dollar and rising inflation is going to be around for a while. These factors should be your guide as you adjust your investments.

    Yes, it’s time to change your investment strategy.
    — Got gold?

    • Curt, I’m taking the opposite view. In fact, I’m evaluating both financials and real estate to buy them, not sell them. I’m also in the process of buying more rental property. And I view gold as a very poor long term investment. It still hasn’t reached it’s high from more than 20 years ago. Agreed that the dollar is weak, which does result in higher commodity prices. But the Fed will have to begin raising the interest rates, which will strengthen the dollar and lower commodity prices. Some exposure to commodities is ok, but buying them now is very risky, and many studies show that although commodities add diversity to a portfolio, they underperform stocks in the long run.

  5. Actually, Curt has it right… The advice you are dispensing here regarding this market is downright dangerous. A common misconception is that “over time, the market always goes up” to borrow a quote from your post. You are looking at this sans many variables.

    You may want to factor in the value of the currency or inflation, current account deficit, the fact that the U.S. is now the largest debtor nation in the world, and that M3 which is no longer provided by the Fed is growing at nearly 16%. I would suggest looking at John Williams work on M3.

    Look, investing is all about trends. In late 98 early 99 many supply disruptions in commodities were identified by people smarter than me. People like Jim Rogers (who cofounded the quantum fund with Soros) began talking about these disruptions and even created an index to track commodity prices. In July of 98 the DOW was at 9330, today its at 11229 or so… Roughly 20% to the positive. The RICI (Rogers Commodity Index) however over the same time period is up 471%!

    With the drop in the dollar factored in, its easy to see how the dow has been crashing for years against items of real value.

    The credit problems in the U.S. are no where near over… Auto loans and credit cards will be the next leg down in the coming consumer led recession. Until all this shakes out, its better to sit in cash than watch your portfolio evaporate. If your portfolio goes down 50%, you have to gain 100% just to get back to even.

    The inflationary effects of the Fed’s poor policy measures hasn’t been felt yet. There is more dollar devaluation to come. The Fed has made it clear that they will reflate housing and ultimately the consumer at all costs… and to do that, there will be another massive money print in the near future.

    Buffett, by the way, does trade stocks. He doesn’t buy and hold everything. He also buys commodities and currencies. He owned more silver than anyone from 4 – 12 dollars. Bershire also made a killing in the currency market buying the Brazillian Real last year.

    Buffett also says, “Diversification is a defense against ignorance”. In looking at your portfolio i see 60% of your holdings are U.S. based and alot of mutual funds and bonds.

    The U.S. economy is projected to be stagnate for the next 8 years, so holding these mutual funds and the bonds of the largest debtor nation the world has ever known is not a prescription for success. This is in fact one of the riskiest portfolios i could imagine.

  6. Jason, I think we are going to have to agree to disagree. Taking your money out of a falling market and putting it in cash would be a huge mistake. And if your predictions of the dollar are correct, I would think cash is the last place you’d want to put your money. Since you seem to respect Buffett, he also said that he tries to be greedy when others are fearful, and fearful when others are greedy. Well, everybody is fearful right now, and many are doing just as you suggest . . . except Buffett. He continues to invest, and in U.S. companies.

    Why don’t you share with us your investment portfolio and why you think its the right approach.

  7. You have to remember, Buffett has already made his money. if you cut 40 billion in half, you are still doing pretty

    well. And in addition, Buffett’s timeline is forever.

    Example, Buffett bought Carmax at 20+ and that position has been cut nearly in half. If you have Buffett’s cash

    position, of course you buy more. If you have no cash position and are fully invested, you either have to wait for

    KMX to go up 100%, sell and sit in cash until the downtrend is over, or sell and put your money elsewhere. who knows how long it will take for

    KMX to go up 100%?

    Buffett began creating a great deal of wealth when he bought good companies at low P/E’s around 7 or 8 35 years ago

    when the baby boomers began entering the work force and consumer marketplace. Again, the trend was in Buffett’s

    favor. He had the largest consumer force that the US had ever seen in the baby boomers buying goods and services.

    They also contributed heavily to the stock market gains as more and more money flowed into 401k’s. Many of these

    people knew nothing about the stock market but in 1974 because of the changes to the laws, became “investors”. Any

    of us can look at a chart and see what the market did as this money floated the market.

    New trends:
    78 million baby boomers are retiring, and money will flow out of the market. But there is a population 10 times the

    size of the one here in the US in southeast Asia. This market is developing a middle class that wants to live the

    way we live here in the states. In order for that to happen, raw materials are needed for building roads, housing,

    electrical grids, cars, busses, trains and of course all the consumer staples. When you factor in the energy needs

    and the supply and demand equation for crude, its easy to see why oil is where it is. This is one of reasons that

    commodity prices will continue up and to the right for the next 8-10 years.

    More trends:
    Currently, Buffett is selling insurance that basically amounts to index calls. In the form of derivative contracts, he guarantees the buyers of this insurance the the market will be higher than when the insurance was purchased in 12 – 15 years from now. He has taken in some 2.5 billion in this derivative. This is beautiful in a lot of ways, but mainly, buffett gets 2.5 billion of todays dollars (in terms of buying power) and will pay back the money in the future if necessary after inflation and any return he may have made. This is classic Buffett, he is looking a future trends in dollar valuation and market valuation. Furthermore, if you bought this insurance when the market was at 13000, it only has to go to 13001 for Buffett to be off the hook for payment, and yet the market has done nothing.

    The simple fact is, its better to get out of a losing position while the trend is down unless you plan to buy more

    of that same position as the market falls… AND be willing to wait whatever amount of time necessary to get out of

    that position. So if your time frame is forever, buy and hope… if your time frame is 3 years, get out.

    How many retirees are getting nervious in this market? I can say that if i had worked 30 thirty years and built my

    nest egg, i would be more than a little concerned with the market over the next few years.

    Say i needed a million, and i achieved that and was ready to tell the boss man to shove it. How many years extra

    would i need to work to make up the difference of even a 25% loss in portfolio value? No one can answer the

    question because no one can tell me exactly how long the markets will be down and how long it will take to make the

    money back. This loss can take not only my money, but valuable time that i plan to spend living my retirement


    To say the markets always go up is naive… and can be dangerous to those without a Buffett like forever timeline.

    The better option is to recognize the trend and alter course accordingly.

    There is nothing technically wrong with owning american companies… There are some good ones out there, but 80% of

    mutual funds underperform the market. You can’t like those odds in an inflationary down market.

    The dollar has been in a down trend for 8 years. So, why would i suggest sitting in cash? i wouldn’t for long

    periods of time. Do this if you are waiting for a particular trend to develop before putting it to work. Obviously

    some return is better than no or negative return. Or do this is if you believe in the lesser of 2 evils: inflation

    while sitting in cash may be less devaluation than your portfolio losses in a bear market. You have to decide.

    Again, because the Fed has shown its cards on reflation, i convert cash to items of value like silver, gold, oil,

    or foreign currencies depending on the circumstances. Anyone can buy these items through your local coin shop, etfs, etns or through everbank for foreign currencies. Remember Gresham’s Law.

    Of course we can agree to disagree all day, and again don’t take my word for anything. look up what people smarter than me are saying. There are some good names in my previous post.

    • Jason, I’m not sure we disagree. If your investing horizon is three years, you shouldn’t be in the market. If you’ve worked for 30 years and are nearing retirement, much if not most of your portfolio should not be in equities. I “invest” a substantial amount in foreign currencies through my investments in foreign funds. I would not move money to precious metals now because the price is too high. At 41, I plan to have my money in the market for decades, so buy and hold is, in my opinion, the best approach regardless of the asset class.

  8. With buy and hold, you are giving away one of your decades to the market, and you have already given away 98 – 08 unless you were in commodities (or real estate and got out in 05). I am not suggesting that you run out and buy precious metals… I am suggesting to the people who have read this that the most successful people buy and hold trends until that trend subsides, then they move into another trend… and so on.

    Investors do not buy mutual funds and hold them regardless of market. Nor do they buy bonds in inflationary environments because they know that in real terms they will have a negative return. If you are Pimco, and can negotiate high rates of returns on senior debt of a particular company, the bond picture is different to a degree. But in general, a 4 to 7 percent bond or t-bill is a net loser. Remember M3 is growing at 16%.

    Mutual funds spread risk… but they also lessen gains. Investors are better off doing what successful investors do… look at all the options and target the trends until that trend runs its course.

    The next trends, to name a few, will be continued dollar decline, travel and tourism, agricultural commodities (due to food shortages and silly energy policy), the yen carry trade unwinding, and clean water shortages.

    Since you mention gold, my 3-5 year target is $2300.00 which is roughly 130% and silver goes to $30 plus. I’ll take my 100% gain over any “get me back to where I was before the downturn” in the market. By the way, oil goes to 170-190. When these targets are hit, it may be time to buy a mutual fund or 2… It just depends on the trends. 😉

    • Jason, now we are back to disagreeing. I have made a ton in the market with boring mutual funds since ’98. And I don’t agree that “the most successful people buy and hold trends until that trend subsides, then they move into another trend… and so on.” I think most overestimate their ability to predict trends. And your 3-5 year target on gold is at best a wild guess. What else could it be? But again, why don’t you layout your portfolio so we can have something concrete to discuss. You’ve obviously put a lot of thought into this, and we could benefit from your perspective.

  9. DR, I agree with most of what you say here. This is a good post. Thanks. Most people who try to time the market end up buying high and selling low. If anyone had figured out how to buy at the low point and sell at the high mark they would be rich indeed, but nobody has figured that out. As far as gold is concerned, for most people that is not a good investment. I suggest that people find some good no load mutual funds and leave their money there.

  10. It wont let me post the whole thing so here it is in parts:

    1) The great myth is that the market always goes up. Welcome to a down / sideways market at best for the next 8 years.

    And BTW, commodities have outperformed stocks since 1959. Read the section titled “Commodities to Again Outperform Stocks” here:

    How do I “know” what i “know”? I am trend following… PPI is higher than CPI, which means that corporate profits will continue to suffer due to higher input costs. Corporations that produce anything but services are victims of inflation until that cost can be passed to the consumer. When those costs are passed to the consumer, wages must rise to maintain current living standards or we enter a painful deflationary recession.

    The Fed will not allow this to happen, as they have already put forth with their lack of action to increase interest rates. Instead of doing the right thing, they have committed 2/3rds of their balance sheet to reflation. And now the Treasury is basically nationalizing the credit market through fannie and freddie. Basically, no one can fail. In order for this to happen, the Fed has to continue devalue the dollar, because Americans can’t stomach the alternative.

    Inflation is the cruelest tax of all. Think of those on fixed incomes… And the Government feeds us junk numbers on CPI and GDP because apparently we can’t see the reality:

    We are entering an inflationary cycle that will not end until the Fed stops printing money and the production (supply) of raw materials of everything, from lead to greasy wool, catches up with demand. Historically, bringing more commodity supply online takes many long years.

    • Jason, you’ve probably filled up my available hard drive space 🙂 Actually, because you put links in the comment, my spam filter held up publishing your comment. I’ve now approved it.

      That said, why don’t you send in a guest post with your perspectives on this topic, and I’ll post it.

  11. Gold is not well correlated with the stock market….its more well correlated with the inflation index. We are on the verge of a massive inflation and devaluation trend due to Democrat profligacy…….expect Gold to go up with the inflation rate and peak when inflation has peaked.

    Not sure how the market will behave during this time. At times bull market rallies followed by bear market dips….its decoupled from gold behavior for the most part.

    We know gold bottomed in 2000…gold cycles last around 10 years or more. It could last longer because more excesses need to be wrung out of the system this time.

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