Fearful Markets Make A Good Retirement

Posted on October 13, 2014 at 10:04 AM PDT by

As the stock market bounces around in October, it’s common for retirement investors to suddenly focus  more intently on their portfolios. After all, a small percentage decline is big dollars when you have a nest egg built up.

Or is it? If you don’t sell your positions, there’s no loss to record. That’s the fundamental point that long-term investors seem to forget. Nobody is forcing you to sell — except you.

When stocks decline in face value, a number of things can happen. It can lead to program trading, where large investment funds sell shares automatically below a certain point. That just drives the decline further.

good retirement

Photograph by Stuart Isett/Fortune Most Powerful Women

On the flip-side, automated trading at other big investment houses will suddenly buy shares because a specific price point is hit. That’s in large part where volatility comes from, big players pushing stock back and forth to arrive at a current reckoning price.

That’s what we mean when we say the market is “efficient.” A lot of people take issue with the idea that stock prices are always correct. They see small-cap technology stocks rising dramatically and then falling within months and wonder how that could be accurate at all.

It’s not accurate if you are intent on pricing a stock to its actual business. But it is accurate  if you understand fully and completely that a stock market is a market. Current prices, moment to moment, do reflect exactly the buyers and sellers are out there fighting to set a price.

Does it matter that the price is “wrong” relative to the underlying business? Not really. As Benjamin Graham, the mentor of billionaire Warren Buffett, once wrote: In the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine.

Which is a way of saying that stock prices can be grossly incorrect at any given moment, due to trading pressures. If you think you can guess how incorrect and buy accordingly, you could in theory make a lot of money, either by going long or short.

In practice, however, the only way to make real money at this game is by using leverage. Now you’re playing with fire, since being wrong greatly increases your risk of massive losses.

Credible and consistent

A lot of people play this game, and that’s what it is, a game, and not one for the faint of heart. If you take the longer view, however, and allow the market to act as a weighing machine, it’s not at all hard to make money.

Assuming you control for costs and your own emotions, stocks have been proven money makers over long periods. Better yet, a balanced portfolio that reduces the ups and downs gives you the best of both worlds, that is, a credible, consistent return with the minimum of risk.

Retirement investors can do well buying into fearful, volatile markets, so long as they don’t fall for the trap of believing that they can outguess the professionals and come out ahead.