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Jul 05 2010

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Rising Stock Market or Falling Stock Market — Which Do You Prefer?


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At first glance, the question answers itself.

Most people prefer a rising stock market unless they’re hoping to “short” the market (betting that it will drop in value, and financially winning if it falls)

Blogger, Financial Uproar  talks about stereotypes—ways of thinking (in many cases, financial) that have no basis of truth or common sense to them.

He jokingly questions whether we need to “beat people senseless” for believing financial concepts akin to the Earth being flat. But perhaps we should just beat on against the tide, to coin a beautiful phrase from The Great Gatsby, and forget about the foibles of others.

I wish I could. But it’s tough to ignore popular sentiments based on the stock market’s general direction—especially for those cursed with pedagogical tendencies they can’t control. My hand is up right now.

For retirees, of course, a dropping stock market is potentially devastating—-because many retirees regularly sell off their investments to put food on the table.

But if you’re a young investor, and you want to see a rising stock market, you’ll remind me a bit of the characters in the recent Leonardo DiCaprio flick, Shutter Island, where the theme involves delusion and, well….insanity.

Now, I don’t want to go around calling people “insane”—but there’s something about investing that mystifies me.

Most people, regardless of their age, want to see the stock market increase in value.

Perhaps it’s a permeating fear of the unknown,  that Kevin explores at his blog, www.investitwisely.com.

But my thought is this. When little kids are taught to memorize their multiplication tables (I’m assuming they still do that?) they should also be taught to draw a 200 year long line graph of the stock markets of the developed world—a line graph including reinvested dividends.

Maybe then, more kids would grow up into adults who learn that the best times to invest are during dropping markets, not rising markets. They’ll conquer fear with logic.

Then, as Jason Zweig suggests, more investors will read headlines suggesting, “Investors lose as markets fall” and edit them in their own minds to something like this: “Gamblers, speculators and retirees (who are selling) lose as markets fall, but investors win.”

Warren Buffett coins it nicely with this little “test” from his 1997 Berkshire Hathaway annual report. I’d like to see this one administered to kids in schools, to encourage a far more educated investing public.

“If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.

But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period?

Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the ‘hamburgers’ they will soon be buying.

This reaction makes no sense. Only those who will be sellers of equities [stock market investments] in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.”

But I’ll open my mind to exceptions. If you plan to invest over the next five to ten years (or more) and you feel good about seeing stock markets rise, then I want to hear from you.

I love to see falling stock prices—because I’m a 40 year old long term buyer. The lower the stock market falls, the happier it makes me. I want to buy cheaply. I’ve memorized that 200 year stock chart myself, and I know that consistently (with no exceptions that I can see) the best buying times for long term investors have been during falling markets or flat markets. And the best attribute for long term investors appears to be patience.

But perhaps I’m the one who requires an education from someone else with a pedagogical urge.

If your hand is up right now, help me out and post a comment.

Nearly every stock market headline celebrates rising markets for investors. So, should I be the one condemned to Shutter Island?

 

 

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About the author

andrew hallam

I'm a freelance finance writer, lucky enough to have been nominated as a finalist for two Canadian National Publishing Awards. I'm also the author of Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School, a book explaining how I became a millionaire on a teacher's salary, while still in my 30s. Working to empower people financially, I'm available to motivate and inspire people on basic retirement planning and index investing. I'm happy to comment on your questions, first, please read the Terms of Use.

Permanent link to this article: http://andrewhallam.com/2010/07/rising-stock-market-or-falling-stock-market-which-do-you-prefer/

15 comments

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  1. avatar
    DIY Investor

    Great post as usual.

    I see a number of reasons why people pile in at higher prices (I'm not saying they make sense) and hold off or get out at lower prices. First off people don't understand that prices move on unexpected news. People see good news push prices higher and don't realize they are looking in the rear view mirror. I don't know how many times I've had to look people in the eye and tell them they have given a great explanation of why the market has risen 20% or has fallen 20% but they have not said anything about where it is headed.

    Secondly, people see prices go up, see investors rush in and take comfort from going along with the crowd.

    I've talked to a number of people in recent weeks who are cutting back on their commitment to equities as price have dropped and I know from past experience that if the S&P 500 moved sharply higher these very same people would pile in.

    A third reason is that people feel validated when they make the "right move" and vice versa. If they buy XYZ and it goes up they feel smart and buy more. Most people don't look at why they bought it or revisit their analysis. When the market is on a real binge like in the late 90s it is just like a gold rush. People act crazy.

    Then of course there are a lot of really smart people who insist on ignoring basic principles. I heard that the average BP employee has 30% invested in BP stock in their 401(k). It is really difficult to feel sorry for these people.

    I have to add that I find it exciting that there are a lot of young people today in the blogosphere talking about personal finance. What is upsetting is that many look at today's down market and don't see it as an opportunity.

  2. avatar
    The Passive Income E

    I would have to join you at Shutter Island :) Maybe we can venture to the light house together :)

    There are so many bargains showing up these days. I just don't have any money to buy unfortunately.

    I would have to say that even for retiree, their plans should have been to move out of equity for capital preservation. My parents are retired and anything close to equity are privilege shares with guarantees.

  3. avatar
    The Passive Income E

    @DIY Investor

    It is very unfortunate that companies do not educate their employees on managing a lot of the benefits the company provides. It's not just BP that has plans allowing employees to buy in the company. In Canada, many companies provide an Employee Stock Purchase Plan and I know many employees just buy and let it be for years and years. Thus making it the largest investment in their portfolio. Many bank employees could have panicked in early 2009 when all the Canadian banks dropped 50%. I know they all provide ESPP to their employees.

    Our company partnered with a life insurance company to provide a group RRSP and they provide some financial advice along the way. The investments are in low fee mutual funds – not company related.

    I tend to sale my ESPP relatively quickly to cash in on the 15% discount. However, I got caught in the drop with my company stock options. That was a bummer.

  4. avatar
    Financial Uproar

    Thanks for the shout out Andrew!

    I just want the stocks that I own to go up. I could care less about the other ones!

    I want cheap stocks, but I also want the market to go up so I can sell those positions at a profit. Luckily for me, the market continually moves in cycles so when some stocks are expensive others are cheap. As a buyer I want cheap stocks and as a seller I want expensive stocks. However, unlike some people, I'm not a buy and hold forever investor. I set a target price and get out once I've hit it.

  5. avatar
    DIY Investor

    @The Passive Income Earner

    Low fee mutual funds are the way to go, especially if they aren't actively traded.

    Stock options can be a problem. When they pile up and they are "in the money" to a decent extent you might get with a good financial planner to develope a tax efficient way of exercising them.

  6. avatar
    Andrew Hallam

    @DIY Investor

    DIY Investor:

    I was also recently reading how many people have their company stock as the primary holding in their 401K. That's a lot of risk on different levels:

    1. No diversification of their 401K holdings as they hold most (if not all) of their money in their company stock.

    2. Their employment is subject to that one company (which is the same one they invested in).

    3. If they also have a corporate pension, it's only as viable as that one company.

    Common sense isn't always that common, is it?

  7. avatar
    Andrew Hallam

    @The Passive Income Earner

    Hey Passive Income Earner:

    You're 100% right. Retirees should have most of their money in guaranteed instruments, like government bonds with a much smaller stock market exposure. That said, they'll probably still prefer to see a rising market, which makes sense to me.

    I've always been fascinated by variable annuities. Well….I'm fascinated at how popular they are. My mother in law owns a couple of them.

    They represent fees on top of fees, and the thing I'm fascinated with is that they're sold as "guarantees" and so many people fall for them. But my thought is this: they're only as "guaranteed" as the solvency of the insurance company. If it goes bust, so much for "guarantee", right?

    From the prospectuses I've read, the only ones that might even be remotely worth the money come from TIAA Cref and Vanguard. The rest of "crazy expensive."

    Anyone with a different view?

  8. avatar
    Andrew Hallam

    @Financial Uproar

    Hey Financial Uproar:

    My strategy is a bit different. I rarely sell equities, but I have sold bonds on a few occasions (rebalancing my account) to buy cheap equities a few times.

    There are people who can do what you're doing, but I'm pretty sure that I wouldn't be very good at it if I tried.

    Are you tracking your long term results compared to an index? If you beat the index over 5 years or more, you'll have some well-deserved bragging rights.

    Cheers,

    Andrew

  9. avatar
    Mich @BeatingTheInde

    But Andrew what if the dropping markets are a sign of impending doom? What if it all comes crashing down in flames and we end up in a greater depression? That's why we investors lose our money by selling during these times, to protect ourselves from the fallout!

    Sorry dude, someone has to take the other side here =)

  10. avatar
    Andrew Hallam

    Hey, no worries Mitch!

    For me, my bonds won't ever fall as quickly or as far as the stock markets. The 1929-1931 example was a good one. Bonds fell, but not that far, relatively.

    If there's doom forever, inflation will wipe out cash anyway. I'm looking at post World War I Germany as an example of that. At one point, it would have cost the equivalent in Marks, of about $1000 dollars to ride the subway and get a cup of coffee.

    If that happens, we'll probably all be on the Titanic. Our cash won't count for squat.

    As for falling markets, I'd place my bets on the world's resiliency. And I'd buy stocks with a DOW at 1000 points (very happily!) if I could.

    Thanks for playing the devil's advocate Mitch. I guess the exciting thing is that nobody really knows. But I can only place my bets with history and take advantage of declines.

  11. avatar
    Mich @BTI

    Totally right Andrew, no one really knows in the end. Odds are in our favor regarding taking the bet on history, one needs to remove the fear factor first.

  12. avatar
    Andrew Hallam

    @Mich @BTI

    Hey Mitch,

    To take your initial side of the argument myself, if we had "inflation" the way inflation existed during the depression, we wouldn't have something akin to Germany, after the first world war. I'd probably be wrong there. I mean, we might. But looking at the fifteen or more years after 1929, we were actually in a period of deflation. So if you had the forsight to sell in 1929 (I think the markets hit their lowest point in 1931) then you could have kept your money in a piggy bank and increased its buying power for many years to come.

    Mitch, you'd be the village King.

    What makes this all so much fun is seeing it as a game of odds, and then if you can become really dispassionate about money itself, you can play those odds in your favour and make money (which might sound odd if you don't care much about it).

    I'm one of those nutbars who enjoys the process more than the proceeds.

    And I'd still love to see the DOW cut in half. Ahhh, I'm salivating at the thought. And the longer it stays there…. I'd better stop gushing while I can.

  13. avatar
    Kevin@InvestItWisely

    I wouldn't mind a declining DOW for a while… not once all my unregistered investments are liquidated out, that is ;)

    There is so much uncertainty no matter where you look (China: huge bubble popping! US: Cannot sustain consumerist lifestyle, etc….) that sometimes it pays to just ride the bull by the horns and ignore the noise, by sticking to a noise-free investment strategy like the ones you recommend.

    Thanks for the mentions!

  14. avatar
    Financial Cents

    For the next 30 years, I'd like to see stock prices low. It will give me a chance to buy as much as I can :) After my 30 years of investing, about 60-70% of my holdings will be in bond ETFs like XBB.

    If everything does bottom out, well, it will be what it will be. Mr. Market likes to run in cycles and so with every high there will be lows. Like you say, if there’s doom forever, inflation will wipe out cash anyway and we all might as well be at the bottom of the mountain when the lava flow runs its course.

    Again, an enjoyable post and discussion.

    Did any of you guys read this? If not, you'll find it interesting..

    http://www.theglobeandmail.com/globe-investor/inv

    Cheers gents!

  15. avatar
    Patrick

    There's a difference between low prices and declining prices. Low prices are good. Declining prices, not so much.

    The benefit of low prices for buyers is obvious, but the benefit of a declining market is more subtle (assuming you're not short selling). A declining market leads to a perception of risk, which increases the risk premium. This must (eventually) compensate for the actual loss you suffer from the decline in order for it to be a good thing.

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