One Year Later: Lessons from the Fall

Last week marked a significant milestone in the investing world. One year ago, on March 9, 2009, the market hit rock bottom in the heinous recession that marred 2007-2009 and shuttered the doors of legendary companies whose longevity seemed a foregone conclusion. Coincedently, on March 9th, IFA published and distributed via email Part II of our article on the Resilience of Capitalism, which was written to get investors to resist the temptations of the siren songs of active management.

Today, the amazing resilience of capitalism has demonstrated itself once again. A year ago, there was genuine fear, despondence and an utter lack of hope that the market could be restored. Many investors concluded that it was truly "different this time."

Then, there was no shortage of media pundits assuring us that this time, our economic goose was not only cooked, but burnt, and doom was certain—so certain that any signs of life in the market were largely deemed to be unreal and unsustainable.

Here's a handful of market predictions from last year that vainly sought to squelch hopes for the stunning rebound that followed. As you read these, keep in mind that on Tuesday, March 16, 2010 the Dow closed at 10,686.

"New research shows corporate bonds have been far better at predicting where the economy is headed than anyone thought. Unfortunately, that suggests the economy is going to get much worse." Justin Lahart, "A Warning from the Bond Market," Wall Street Journal, April 9, 2009. The Dow closed that day at 8,083.

"The March stock market rally that fueled hopes of a broader economic recovery was deceptive because 'real money' investors stayed on the sidelines." Anju Gangahr and Chrystia Freeland, "Head of NYSE Cautious over Rally in March," Financial Times, April 16, 2009. The Dow closed that day at 8,125.

"Without a sustained improvement in the credit market — the seat of the crisis — it seems irrational to expect a durable move higher in equities." Richard Barley, "Bond Markets Don't Buy the Rally," Wall Street Journal, March 26, 2009. The Dow closed that day at 7,925.

Pity the poor investors who heeded these warnings, and the thousands of other warnings just like them that littered the headlines of the papers, even as the rebound was in full force.

It's never easy to keep your head when so many others are losing theirs. However, a true understanding of the realities of market randomness, market efficiency and market history will avoid the knee-jerk reactions that can deal a deathblow to investor success. A true understanding of how much risk one can endure and the acceptance that this endurance will certainly be tested is critical for keeping us buckled into our seats during market turbulence.

Bottom line, if you have a long time horizon and you can develop nerves of steel, you give yourself the highest probability of investor success—the type of success that comes from intelligent and prudent investing, not speculation about short-term movements and which politician will say what.

Mark Twain once said, "October is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February."

Twain reiterates the indisputable fact there is no good time to speculate in the stock market. One of the main reasons for this is stock prices are fair because everything has been absorbed into the price. There is widespread dissemination of information available to all market participants. Every bad thing that drove prices down was already baked into stock prices. In the words of David Booth, "You've already paid for the risk, you may as well stick around for the expected return." The entire market follows the general principle of "fair price."

Pundits misguide investors that they can foresee the storm that will batter one's portfolio? Well, they better be more accurate than your local weatherman because if they're not on RIGHT on target, you can lose out on huge returns. And unlike the weatherman, there are no Doppler satellite images to follow: it's randomness. Accept it, live with it, and profit from it.

Big down days and big up days frequently come right next to each other. This is volatility—and it is why you have to stay in the markets to get the markets' superior return. Over the long-term investors are rewarded for the risks they take. You can't avoid risk and you can't cheat it. Risk is the source of returns. You do, however, have the option of lowering risk or avoiding it through the use of lower-risk or risk-free investments, but you will give up returns for this peace of mind.

As we mark the one year anniversary of the bottom of the recent and deep recession, ask yourself how many investors pulled out of the market in February or early March, terrified they were going to lose what they had left? How many do you think were smart enough to jump back in as the market came storming back. To this day, over a year after the bottom, there are people who are still nervous about getting back into the market. Imagine the types of returns someone would have missed out on if they were still waiting.

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We have often heard, when you lose, don't lose the lesson. One year later, IFA's lesson remains unchanged:

It's always the right time to invest the right way.

The Siren Songs of Active Management

Investors must tie themselves to the mast to resist the incredible urges to trade.