Geoff Wisner

The Importance of Doing Nothing

Sooner or later the stock market will go down. What will you do then?

Early last year [1995], the Dow Jones Industrial Average was under 4000. By the end of the year it was over 5000. The Vanguard Index 500 fund went up about 37% in 1995 -- almost four times the historical average of 10% for the US stock market.

All this is great (especially if you already have some investments), but how long can it last? The current bull market is one of the longest in history. There has not been a "correction" (i.e., drop) in the US stock market of 10% or more since 1990, or 20% or more since 1987. According to various measures such as price-earnings and price-book ratios, stocks are either somewhat overpriced or drastically overpriced.

Question: What should you do in the event of a correction, or even a crash like the one on October 19, 1987, when the Dow dropped 23% in a single day?

Answer: Nothing.

Over the long haul, each of the four stock funds in our 401(k) plan should do reasonably well. Almost the only mistake you can make with your 401(k) investments (aside from leaving too much in the money-market fund) is to sell when the market goes down.

Ups and downs in the stock market are perfectly normal, as are occasional big corrections. So long as you stay invested, your gains and losses are just on paper. But the minute you sell -- that is, when you move money from one fund to another -- you are locking in your loss. Many people did this in 1987, when if they had just done nothing they would have recouped their investment in a fairly short period of time. The Index 500 fund, for instance, climbed back to its previous high in about 18 months.

So if you had been invested in the Index 500 in 1987 you would have "lost" 18 months, right? Not really. Because if you were investing a fixed amount every month, as you do with a 401(k), you would have picked up shares of stock at a depressed price when the market was down. When the market went back up again, holding those cheap shares would boost your profits. As a result, you would break even before the eighteen months were up.

This is what "dollar-cost averaging" is all about: By investing the same amount of money every month, you buy more shares when prices are low and fewer shares when prices are high. Over time, with this completely automatic strategy, you end up paying less-than-average prices for the shares you own.

An even more dramatic example is the Crash of 1929 and the Great Depression -- the worst period for stocks in this century. According to Mutual Funds magazine (July 1995), if you had been around in 1929 and invested, say, $1,000 in the stock market just before the crash, it would have taken about 25 years before you got even. However, if you invested the same amount in six annual installments, beginning in 1929 and buying each year at the peak (i.e., the worst time) you would have broken even in only six years -- and you would have continued to profit from the shares you bought at beaten-down prices.

So, if you've allocated your 401(k) investments in a way that you're comfortable with, the best advice may be to continue investing regardless of what's happening to the markets. As Jonathan Clements put it recently in the Wall Street Journal, "If you want to retire rich, your best bet is to save like crazy, invest in a broad collection of stocks, then close your eyes, clench your teeth and don't hold your breath while you wait."

Published in Bread and Cutter, February 1996.



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Geoff Wisner The Importance of Doing Nothing Sooner or later the stock market will go down. What will you do then? Early last year [1995], the Dow Jones Industrial Average was under 4000. By the end of the year it was over 5000. The Vanguard Index 500 fund went up about 37% in 1995 -- almost four times the historical average of 10% for the US stock market. All this is great (especially if you already have some investments), but how long can it last? The current bull market is one of the longest in history. There has not been a "correction" (i.e., drop) in the US stock market of 10% or more since 1990, or 20% or more since 1987. According to various measures such as price-earnings and price-book ratios, stocks are either somewhat overpriced or drastically overpriced. Question: What should you do in the event of a correction, or even a crash like the one on October 19, 1987, when the Dow dropped 23% in a single day? Answer: Nothing. Over the long haul, each of the four stock funds in our 401(k) plan should do reasonably well. Almost the only mistake you can make with your 401(k) investments (aside from leaving too much in the money-market fund) is to sell when the market goes down. Ups and downs in the stock market are perfectly normal, as are occasional big corrections. So long as you stay invested, your gains and losses are just on paper. But the minute you sell -- that is, when you move money from one fund to another -- you are locking in your loss. Many people did this in 1987, when if they had just done nothing they would have recouped their investment in a fairly short period of time. The Index 500 fund, for instance, climbed back to its previous high in about 18 months. So if you had been invested in the Index 500 in 1987 you would have "lost" 18 months, right? Not really. Because if you were investing a fixed amount every month, as you do with a 401(k), you would have picked up shares of stock at a depressed price when the market was down. When the market went back up again, holding those cheap shares would boost your profits. As a result, you would break even before the eighteen months were up. This is what "dollar-cost averaging" is all about: By investing the same amount of money every month, you buy more shares when prices are low and fewer shares when prices are high. Over time, with this completely automatic strategy, you end up paying less-than-average prices for the shares you own. An even more dramatic example is the Crash of 1929 and the Great Depression -- the worst period for stocks in this century. According to Mutual Funds magazine (July 1995), if you had been around in 1929 and invested, say, $1,000 in the stock market just before the crash, it would have taken about 25 years before you got even. However, if you invested the same amount in six annual installments, beginning in 1929 and buying each year at the peak (i.e., the worst time) you would have broken even in only six years -- and you would have continued to profit from the shares you bought at beaten-down prices. So, if you've allocated your 401(k) investments in a way that you're comfortable with, the best advice may be to continue investing regardless of what's happening to the markets. As Jonathan Clements put it recently in the Wall Street Journal, "If you want to retire rich, your best bet is to save like crazy, invest in a broad collection of stocks, then close your eyes, clench your teeth and don't hold your breath while you wait." Published in Bread and Cutter, February 1996.