MW The No. 1 enemy of your 401(k) plan may be you
By Brett Arends
Here's the truth about the portfolio strategy you might be following
When the stock market did a face-plant earlier this week, I went and checked some numbers. And I thought: Yep. Like clockwork.
Yep: Individual investors have been feeling bullish.
Yep: Joe and Jane Q. Public have been pouring money into the stock market - after this year's big run-up. The Investment Company Institute reports a surge of buying of mutual funds and exchange-traded funds that invest in U.S. stocks in the week to July 17, the most recent week for which we have data.
Yep: People have been buying stocks with borrowed money, in the hope of making a fast buck in a booming market. Margin debt had already risen 15% this year through the end of June.
And yep: People have been aggressively using call options - speculative derivatives that make money only if the stock market goes up - for the same reason. Doug Ramsey, chief investment officer at the Leuthold Group, a Minneapolis-based financial-planning company, notes that bullish speculation in the two most popular stock-market exchange-traded funds used for that purpose, the SPDR S&P 500 ETF SPY and the Nasdaq 100 index fund Invesco QQQ Trust QQQ, recently reached extreme measures. "The speculation in these two ETFs, the bullish speculation, the call buying, exceeds anything that we saw at the peaks of 2018, pre-COVID, in 2020 and late '21-early '22," he said in a podcast this week.
To give you an illustration: Margin debt at the end of June, when the S&P 500 was around 5,500, was 27% higher than it was at the lows in October last year, when the S&P 500 was at 4,200. Logically, if we're going to buy stocks aggressively on margin, we should be doing it more when they are down and less when they are up.
No wonder studies show that ordinary investors typically make way less from the stock market over time than they should. In the 30 years to the end of last year, the S&P 500 produced total returns of about 1,700%. The average investor got about 900%. They sold when stocks were down and bought them back when they were up. These numbers are, at least, better than they used to be.
In an ideal world, we'd do the reverse. When stocks fell and were cheaper, we'd buy more. When they were up and more expensive, we'd buy fewer. Alas, that's incredibly difficult to do.
It's why the most successful long-term investment strategies are as much about keeping our emotions out of our decisions as they are about investing in the best assets.
There is nothing magic about the so-called "balanced portfolio" of 60% stocks and 40% bonds. Some people go for 70% stocks and 30% bonds. Or 80% stocks and 20% cash. Or 90% stocks and 10% cash. One of the most intriguing portfolios is Ramsey's All Asset No Authority portfolio, which consists of equal amounts invested in the S&P 500 index of large-cap U.S. stocks SPX, the Russell 2000 index of small-cap U.S. stocks RUT, the EAFE index of international stocks, gold, commodities, real estate and 10-year Treasury bonds. Thanks to the gold and commodities, this portfolio did well in eras like the 1970s, when stocks and bonds both did badly.
All these strategies produce different return profiles over time. But a superpower of these portfolios is their fixed proportions. If you're keeping 70% of your money in stocks and 30% in bonds, for example, then you automatically end up buying more stocks when they are down and selling some when they are up. All you have to do is check your portfolio periodically - once a quarter, twice a year - and rebalance it. Sell some of what's gone up the most and buy some more of what hasn't, to bring the proportions back into line.
But every new generation of investors typically has to learn it the hard way. Which is why they've been borrowing more money to buy stocks only now that they've become more expensive.
-Brett Arends
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(END) Dow Jones Newswires
July 26, 2024 10:54 ET (14:54 GMT)
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