Subscribe to this feed
Top 3 stock market myths
From 1983 to 1998 investors experienced one of the greatest bull markets in stock market history. From this golden era, three mantras emerged to become accepted as conventional wisdom:
- buy and hold
- the market always goes up
- you can’t time the market
As someone who used to subscribe to these truisms, I will explain why this conventional wisdom no longer holds and how following them in today’s market will lead to financial ruin.
Building the myth
While the myths themselves have been with us for several generations, my generation first came in contact with them during the bull market of 1983 - 1998 (note: by market I am referring to the Dow Jones Industrial Average).
Anyone who in invested $1000 in 1983 would see their money multiply almost 9 times by the time 1998 rolled around. This bull market gave investors an annual average return of 15.7% over 15 years.
Helping entrench these myths were the mutual fund companies. It dovetailed nicely with the industry’s rallying cry at the time - asset accumulation. Marketing a fund became just as important as managing the money.
With graphs, charts, and lots of historical data, mutual fund companies painted a pretty compelling picture for why investors could count on the market to go up. And when the inevitable bumps did come, the market always recovered which made timing the market moot.
But perhaps the greatest reason people subscribed to these myths was that they worked. For this market, buy and hold gave people a great rate of return for doing absolutely nothing.
It was the doing nothing that attracted a lot of investors. They didn’t have to think. With history and the numbers on their side, it was easy to abdicate responsibility and have faith that the market would always go up. And for over 15 years it did.
All myths are local
There is nothing wrong with conventional wisdom. As Jerry Seinfeld once said, ‘Sometime the road less traveled is less traveled for a reason.’
Unfortunately, conventional wisdom breaks down when applied outside of the context and boundaries from which they were formed. This is especially true of financial markets. There are no rules that work in all cycles.
Investors get in trouble when they apply one set of market myths to a completely different market cycle. When you look at markets over 100 year periods, the trend is indeed up. When you look at markets in 10 to 20 year cycles however, things look quite different.
For one, the market doesn’t always go up. From April 1930 - July 1932 the market lost 86% of its value.
Secondly the market can go side ways and deliver no returns for upwards of 20 years. Look at the returns investors received over these market cycles of the last century.
For many 20 year periods the market returned little no capital appreciation. Not only would buy and hold have put peoples capital at undo risk, they would have lost the opportunity to put that capital to use else where. The market does not always rise, nor are you guaranteed a return of 11% per annum.
If you think these crashes are things of the past, ask Japanese investors how the felt buying and holding stocks on the Nikkei index from 1989 - 2003.
It took 14 years for the bear market to bottom after a market peak in 1989. And this is Japan - one of the most prosperous, hardworking, industrialized nations of the world.
What does this all mean?
I don’t want to give the impression that people should not invest in the stock market. I believe the stock market is a wonderful vehicle of investment. And when treated with respect, it is a wonderful way for people to get a decent return on capital.
But as someone who grew up applying these myths, I was jarred when I read Maggie Mahar’s excellent book, Bull! A history of the boom and bust, 1982 - 2004, to learn that not only were these myths not always true, but that applying them in today’s market could be disastrous.
Does this mean a crash in the stock market is pending? I don’t know.
But I do know that the strategies that served us so well for the last 20 years will require changes for the next 20. With the market recently punching through an all time high of 13,000, the real estate market beginning to cool, and consumer debt at one of its highest levels, many wonder if the market can go much higher.
While it is certainly beyond most of us to predict, we can make educated guesses. And after enjoying one of the great bull markets in history, the tide may be heading out.
May 1st, 2007 at 9:52 am
Good job on this JR.
I think a lot of the market drop in Japan was demographics. When the big drop happened, there were a great number of people who were retiring in Japan. Obviously, they sold stock to get into more secure holdings and the market dropped.
We are going to get the same effect in Canada and the US in a few years as the same demographic shift occurs. There were more people that were born in 1961 in Canada than any other year in history. As “freedom 55″ occurs in 2016 for those born in 1961 (not that far away) there will be a shift to more secure holdings in people’s portfolios.
May 1st, 2007 at 10:06 am
There’s nothing really new here - most financial advisors will advise people to reduce their equity holdings as they approach 10+ years until retirement, because of these facts.
You also should keep in mind that equities would be part of a balanced portfolio and that continuous purchases or rebalancing of the portfolio over time will mitigate the ups and downs somewhat. But I agree that most people should put more thought into their investments and need to adjust them as their situation changes.
May 1st, 2007 at 10:18 am
Your right Will - this is nothing new.
What was new to me however was that I could dollar cost average into the stock market and not make any return for 20 years.
This debunked, what was for my, one of my cornerstones to investing. Buy and hold, on faith the market will rise, and all will be good.
May 1st, 2007 at 10:18 am
Good point on Japan Paul - demographics will definitely play a big part in the next 10 years in North America and Europe.
May 1st, 2007 at 10:27 am
Hence these developments… the surge of investment came ove to the Forex market.
The Stock market is a great indicator of what will happen to the Forex market.
May 1st, 2007 at 8:59 pm
Hey JR - very interesting read. I am an investor based in Australia and our ASX is also hitting new heights. We also have a lot of fund money being pumped into the market as the Federal Government is pushing retirement savings for the 55 year olds and over.
In isolation the DOW pattern is interesting, however we are in an unprecedented time globally with China increasingly becoming the “sneazing elephant” and India very close behind. Thomas Friedman was on tv last night as he is in Aus at the moment talking about his “flat earth” observations and the need for green strategies. I am interested how this approach would effect financial markets in the same way it effects information technolgy and labour sourcing.
Regards
May 2nd, 2007 at 11:21 am
Me too Andziro. Australia has had a great run with China demanding many commodities. Combine that with your Super Annuation program and you have a lot of money entering the market.
When working at AMP Capital in Sydney, I was amazed at the returns, and the outlook for Australia, and their relation to China and other SE Asia neighbours.
Another area I think Australia will be impacted in is tourism. When the Chinese middle class discovers your beautiful beaches look out. Australia is not as far away as people think.
Thanks for the comments. JR
June 20th, 2007 at 12:42 pm
The information that everyone else already has is already built into stock prices. So even if it’s correct, you can’t profit from it. That, in a nutshell, is the efficient market hypothesis — and it’s maddeningly correct.
July 18th, 2007 at 10:13 am
Good+Site%21+Keep+Doing+That%213
July 19th, 2007 at 8:41 am
I think that the time frame of change is changing. boom and bust happen at faster rates. Volitility is greater and i thnik the focus should be more on capturing volitility.
July 30th, 2007 at 3:13 pm
Great+site%21q
July 31st, 2007 at 6:18 pm
O%2C+super+project.a
August 14th, 2007 at 6:05 pm
Thank you!
February 19th, 2008 at 6:51 pm
cheap stock investments
high yield investments
March 5th, 2008 at 3:13 pm
the insurance companies don’t want you to know
Information on the life insurance industry
March 9th, 2008 at 12:58 am
Quincysportsfield8832$anchor$basketball Betting,final Four,final Four Betting,final Four Gambling,final Four Sports Book,final Four Sportsbook,march Madness,march Madness Betting,march Madness Gambling,march Madness Sports Book,march Madness Sportsbo…
Quincysportsfield8832$anchor$basketball Betting,final Four,final Four Betting,final Four Gambling,final Four Sports Book,final Four Sportsbook,march Madness,march Madness Betting,march Madness Gambling,march Madness Sports Book,march Madness Sportsbook…