Since March 2, 2009, a significant investor demographic has sat frozen on the sidelines while the S&P 500 has soared skyward by more than 95 percent. To get a sense of just how much cash left the market and headed for the sidelines, a September 2009 Bloomberg study reported that record levels of bank deposits and money market funds reached a shocking $9.55 trillion—enough to buy all the companies in the S&P 500 at the time.
Considerable portions of these reserves have courageously found their way from the sidelines and into the market over the past 18 months. Still, many investors remain skeptical. To their consternation, these befuddled bystanders have witnessed the Dow Jones industrial average march steadily past 8,000, through 9,000, then 10,000, 11,000, and finally the 12,000 barriers.
For such investors, each new milestone has been both painful to witness as well as hard to believe. The market’s growth appears unsustainable and tenuous at best. The unemployment numbers are dismal. The backlog of bad debt still awaiting destruction is formidable. An impressive litany of other very real national and international economic concerns leave these would-be stockholders frozen in place, unable to make any investment decision. These investors remain motionless, paralyzed by uncertainty, unable to do anything more than simply watch the markets fade away in the distance while they stand holding their diminishing bag of cash.
How can investors suffering from paralysis of analysis break free and once again participate in the markets? Here are three approaches to consider:
Jump into the market. Jumping into the markets with a Dow average north of 12,000 may feel akin to jumping into Lake Michigan for the annual Polar Bear Plunge—in other words, crazy. But before you write off the idea, step back and consider the possible wisdom of this approach.
Wading into these frigid waters becomes more rational if you do so clothed in the warmth of a truly globally diversified portfolio. By adding U.S., foreign developed and emerging market stocks, commodities, U.S. treasuries, foreign and corporate debt, Treasury Inflation-Protected Securities (TIPS), and more to your portfolio, you stand largely protected from your worst fears. Additionally, disciplined rebalancing will allow you to do what few investors have the true grit to pull off—trim winners and buy losers, thereby reducing risk and positioning your portfolio for future market shifts.
Finally, an investor should not lose sight of his time horizon. If a retirement investor has a time horizon of 10 years or more, a 10 percent downside move in the markets will not ultimately adversely affect that investor’s retirement dreams. Eventually, markets will sort themselves out and offer rewards to those who participate in their efforts.
Dollar-cost average into the market. Jumping into the markets isn’t for everyone. That is why advisers have recommended the practice of dollar-cost averaging for years. The idea behind dollar-cost averaging is that the investor will purchase fewer shares when prices are high but more when prices are low by investing a fixed amount of money at regular intervals. This will eventually drive the average cost per share down to lower levels. Dollar-cost averaging is a time-honored investment technique and it helps prevent investors from investing large amounts of money at the wrong time.
The challenge with dollar-cost averaging is the potential negative effects of transaction costs related to each trade. These effects can largely be minimized, however, if you employ the many quality exchange-traded funds that trade for free at brokers such as Charles Schwab, Fidelity, and Vanguard. The approach does require discipline and a predetermined plan, but can prove to be an effective cure for investor paralysis.
“Put” your way into the market. Selling puts to move into a stock position is a sophisticated trading technique requiring education and diligence. If used wisely, however, selling puts can be an effective way to move from the sidelines and into a stock you are already planning to buy.
When you sell a naked put, someone is paying you to enter into a stock position you already intend to own. If the put expires worthless and fails to hit your strike price, you simply collect on the value of the put, allowing you to pocket the profit and write a new put for the future. If the stock hits your strike price, you then own the stock you intended to buy all along, but were paid a premium along the way in the form of the put. If the market crashes and your stock goes dramatically down, you are forced into the stock at your strike price and will lose money, but only money you would have also lost by simply buying the stock outright.
This sophisticated trading technique is risky, but for the educated and astute, it can help you move from the sidelines back into the market. It is extremely important to do your research before employing this technique.
Breaking free of the paralysis of analysis is essential if an investor wants to enter and benefit from the eventual growth of economies and markets. A globally diversified and rebalanced portfolio will provide protection and participation in the market’s growth. Whether you jump in, wade in, or get clever with puts, getting in is a good thing for long-term investors.