What to do now: Should I be selling my stocks now? Is now a good time to be buying stocks? I often get asked one or both of these by friends and people I meet at social events who find out what I do. Given the popularity of those making predictions on financial programs, many investors want to hear answers to these questions. I will consider stocks to mean the broad market as represented by the S&P 500 or a total market index. Of course, I in effect answer these questions for clients by managing their accounts. Under the reasonable assumption that readers have not placed all of their possible equity investments with me, I will discuss how I answer the questions when asked in person.
When asked if they should be selling, I point out that it would have been much better to have sold months ago and that I had my client accounts mostly in cash since last June. That produces the expected reaction of wishing they had done that and had known then that the market was going to fall. I am honest enough to point out that I follow quantitative models and that I did not know or expect the extent of the plunge in stocks in the second half of last year. Moreover, I doubt that they would have acted even if they had known what the model signaled. My hope is that they will become interested in engaging my services, but so far that has not happened.
My answer to their question is that it is too late for them to sell. I quickly add that does not mean that the market won’t go lower as it quite well may. I explain that if they are still in the market and get out now, it is highly unlikely that they will decide to buy back in at prices lower than the current ones. Numerous studies have shown that typical behavior is selling in a panic after stocks have fallen quite a bit and then being too afraid to own stocks until they are much higher. I also point out that money that will be needed before three to five years should never be in stocks if losing a significant portion will result in not having enough for the eventual purpose of the invested funds.
The question about whether they should buy stocks now is more difficult for me, and I usually try to avoid giving a direct answer. The first problem I have is a lack of information about their financial situation and objectives. That means I have no idea what levels of investment in stocks are suitable. The second problem, which I point out, is that if I tell them when I think it is a good time to buy stocks, there is a good chance that I won’t be able to tell them when I think or my models say it is time to sell. In general, it is a very bad idea to act on a “tip,” hot or otherwise, legitimate or not, because you are unlikely to find out about when to exit your position.
If that does not satisfy them, I point out that my trend following models are currently negative so I am not putting client accounts that I manage using the models back into the market yet. On the other hand, stocks are certainly a better value than they were in late 2007 and the first half of 2008, and by asking the question they have indicated they want to buy fairly soon. I encourage them first to determine what level of stock ownership is appropriate as a long-term holding—not necessarily the twenty years I used above, but at least five years. If they are willing to be patient and not get scared and sell if the market goes lower, I suggest scaling into to stocks. For example, they could buy an index fund now with about a quarter of the money they wish to invest. Then every three months, they can invest another quarter until fully invested. If the market falls, they will acquire the later shares at lower prices. If stock prices rise, they will be ahead on the initial purchase, and the foregone profits are easier to take than the larger losses from having the entire investment go down.
It would be better, certainly for me and quite likely for them, if they would become clients and have me manage part or all of their investments. Since that is not likely to happen, I think the guidance provided above is reasonable and will not result in my losing any friends.