If you listen to our leaders, be they in business or government, it seems there’s a competition to frame our financial situation in the direst terms. Our media hypes the times so that we stay tuned in. We hear terms like meltdown, nose-dive, crash, collapse, and Great Depression.
We found a great white paper by Marvin Bolt of Alpha Plus Advisors [PDF]. It’s well worth your time to read the full paper to understand historical mutual fund flows and market performance.
Specifically, he looks specifically at what individual investors did with their money during four recent periods:
Stock market crash
In the first quarter of 1987, individual investors placed a then-record amount into the market as stock prices rose. Of course, in October of that year, the stock market crashed. Individual investors responded by withdrawing record amounts of money as the market hit a low we haven’t seen since.
Gulf War & recession
In the second quarter of 1990, there was a huge inflow of funds as the market hit its high for the period. By the third quarter, investors were pulling money out just as the market hit another low point.
Dot.com bubble and 9/11
At the height of the dot.com bubble, investors poured a new record amount of money into the market in the first quarter of 2000. The S&P 500 hit a high in that same quarter. Things soon changed as the market began falling, reaching a low in the third quarter of 2002, just when individual investors were withdrawing record amounts of money.
Housing bubble & mortgage crisis
The market hit its high in 2007 as investors poured money in again amidst the euphoria. While all the data is not yet in, it appears that in October of this year, a new record amount of money was pulled out of the stock market.
Rising above the crowd
We want to buy low and sell high. History shows that the crowds tend to do the opposite – they buy high and sell low. They invest heavily during the bubble and get out during what we’ll call the crater.
Think about what’s happening right now. Stock prices have been falling. But for every seller, there has to be a buyer! Who’s buying and who’s selling? Morningstar has a great video that’s well worth your time to gain the proper perspective on this crucial point.
To rise above the crowd, you can’t think like the crowd. You have to do the opposite.
So take a deep breath. If you don’t need the money for five to seven years, the odds are heavily in your favor. If you need the money sooner than that, stocks probably aren’t the best investment for that money. Because we’ve relearned just how risky stocks can be in the short-run.
Educate yourself to maintain the proper perspective. We can’t count on our media or our leaders to do this for us. Knight Kiplinger wrote a fantastic piece explaining all of the differences between today’s situation and the Great Depression. We highly recommend that you read this article to see why he thinks we’re not ready to jump over the cliff.
Market timing is a risky game. Since the crowd tends to get it wrong, perhaps the best way to get it right is to keep investing through the whole cycle. You’ll buy fewer shares when the market is up. You’ll get some great deals when the market is down like it is now. Over time, you’ll end up with a decent return.
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