In times of extreme market volatility, investors turn for advice to experts to explain what is going on. The financial media goes into overdrive, scheduling specials where market activity of the day is endlessly dissected and advice is confidently dispensed. Everyone has an opinion and there is little consensus. Either this is the beginning of the end or merely a blip in a bumpy road.
The overriding question is: What should investors do, given market gyrations? Flee to safety? Stick it out and hope for the best? Wait for another signal? It’s all so confusing.
Here’s the problem: No one knows. They just pretend they do.
The future direction of the market cannot be predicted from past events, no matter how stark those events may be. Investment pundits who pretend to have special insight into the short term direction of the market are acting irresponsibly and often cause great harm to investors who are relying on their non-existent expertise.
If last week taught us anything, it is that stock prices follow no discernible pattern. There is no trend to decipher. Yesterday’s market activity gives you no insight into tomorrow’s stock prices. But there is something that would be useful to know if you really want to predict the future direction of the market: tomorrow’s news. Stock prices react to tomorrow’s news. Today’s prices incorporate all publicly available information about all stocks in the market. No guru can add anything meaningful to the collective wisdom of all investors in the market. Since they don’t know tomorrow’s news, their views on what will happen in the future are meaningless and irresponsible.
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We had extremely volatile markets in 2008, when the S&P 500 index lost 37 percent. How did the market react? It was up approximately 50 percent of the trading days and down the other 50 percent.
Here’s what we do know: Investors who intensely follow the financial news and make investment decisions based on predictions lose money. Those who ignore market volatility (as difficult as it can be to do so) and stay the course, reap the returns of the capital markets.
This buy and hold strategy worked even during the Great Depression. An all stock portfolio lost 72 percent of its value from July 1931 through June 1932. Most investors panicked and dumped their shares. Those who held on realized a 264 percent gain in the following year.
The financial media does a great disservice to investors by encouraging panic and fear. Guests on these shows who peer into their crystal ball and see gloom and doom or rapid recovery are participating in this charade. They have no better perspective on future market conditions than you do. The only question I have is whether they are being dishonest with your or with themselves.
Your reaction to volatile markets should be serenity. I refer to it as a call to inaction.
Dan Solin is a senior vice president of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, and The Smartest Retirement Book You'll Ever Read. His new book, The Smartest Portfolio You'll Ever Own, will be released in September, 2011.