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Which is Throwing Good Money After Bad?

Right now, there’s a temptation to feel that we’re throwing good money after bad when we invest. And are we? Well, some people are (mis?)taking Jim Cramer’s advice and pulling out of the market. But here are a few things to consider before pulling your money out:

  1. What Cramer actually said was that money for the next 5 years shouldn’t be in stocks. That has always been true. I don’t like Cramer and I think that he has a bad effect on investors (and perhaps the market) overall, though some of his non-investing stuff is ok. But what he said was simple conventional wisdom. This is why you have an emergency fund and short-term savings or why you should build them. Many of us will not need our retirement money (especially not all of it) in the next 5 years, so that should stay put.
  2. The market has already gone down significantly. You’ll have less money to buy in and be able to buy fewer stocks when the price goes up. By taking your money out, you’re losing the chance to get it back. Yes, that sounds like gambling, but stocks have always been a gamble of sorts, which is why most stock experts recommend asset allocation which includes bonds and perhaps cash.
  3. This is probably not the end of the financial world. Yes, it’s bad. It may take a while for the market to recover. But that does not mean that the market will not eventually recover.
  4. It’s always been better to buy when the market is down. Unless the stock disappears entirely (which is why it’s better to buy the market by indexing), then the best way to make money on it is to buy low and sell high. That has always been a key tenet of investing, whether in a bull market or a bear one.

Now, you might be throwing good money after bad if:

  1. You don’t practice proper asset allocation. If you haven’t been allocating properly already, this is as good a time as any to start. It does have to be hard. A good start might simply be a good S&P 500-based index fund and a solid bond fund (e.g. VFINX and VBMFX). Allocate percentages based on how close you are to retirement (less in bonds for the young, more in bonds for the old). If asset allocation feels to complicated, consider using a target retirement fund from a firm like Fidelity or Vanguard.
  2. You try to time the market. Market timing is fine as a hobby. If that’s what you want to do with your disposable income, go for it. But if your income isn’t disposable, then you can’t afford to take that kind of chance.
  3. You try to get rich quick. Some days I wonder if I’m cut out to work at a library. I see a lot of people checking out books which make my heart sink. Maybe they’re checking out day-trading books from 1999 or books on how to make a quick profit in real estate with no money down (from 2002). I wonder when it would be wise to speak up and when it would be butting in out of turn. They don’t come to the library to get my opinion on personal finance. And I’m not an expert. But I know enough to know that these books are not a safe course of action, especially now that they’re so out of date. It’s hard to argue for purging them, however, because they’re so popular. In the end, the library is about making the books people want available, it’s up to them to mark smart decisions with the information.

These are bad practices at all times and in all markets. Like many bad practices, they sometimes yield good results in the short term. You may run red lights for years before you get into a traffic accident or have a speeding ticket. That does not make it safe or a wise choice on your part.

I can’t say I’m not scared at times. But the best thing we can do is not to let fear paralyze us or influence decisions that are against our better judgment. If we do so, we’ll have all of the pain and gain little or nothing by the experience. Instead, this is a time to learn more about general theories of asset allocation and how they work with our personal investing goals and risk tolerance.

For those of us who aren’t yet at retirement age, this is particularly important. If we learn now, then we can protect ourselves in the future. We must not forget the bubbles and bursts, because they happen in big and small doses. We must not get so intoxicated when the market goes back up that we forget it could happen again.

{ 2 trackbacks }

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Jeremy October 9, 2008 at 12:38 pm

Good post. You know, sometimes I wish the pundits like Cramer and Suze Orman would just STFU sometimes.

You wouldn’t believe the phone calls I’ve received the in past few weeks. People calling in and freaking out because they overheard someone say Cramer said to sell all their stocks, and people wanting to liquidate their 401k because Suze Orman was on Oprah and said to pull your money out of anything that isn’t FDIC insured.

People don’t listen to the whole story, and all they hear is a sound bite or overhear someone at the water cooler and before you know it they are freaking out for no reason. And it makes my job that much harder.

Fabulously Broke October 9, 2008 at 5:43 pm

Great post. Am linking this!

Dad October 9, 2008 at 9:18 pm

As usual, some excellent advice. However, the story isn’t so simple for those who are approaching retirement or are already there. We don’t have the 5-15 years it may take to recover in the market or mutual funds. For those people, I seriously recommend consulting a financial expert. Be very careful also of those brokers working for large brokerage houses who want to sell you the stock de jour. I’ve learned that they are required to push this stock on their clients even if it doesn’t pass muster as a timely investment. In my own case, I’ve had to stop the hemorrhaging. But I think for younger people, especially in their retirement accounts, will do best if they hang on to sound investments and wait for them to recover. This is certainly a place for something like the index funds where the exposure in the fund is broad and not focused on some specialty. The financial companies are a bad area right now and some of them are failing making their common stock worthless and that diminishes any fund invested in them. We saw today that GM and maybe Ford may be badly hit. I wouldn’t want a fund that specializes in US car making. Diversification is needed and the index funds look like they may meet the bill.

Funny about Money October 10, 2008 at 12:07 am

As a practical matter, even if we’re close to retirement — as I was until the past week or two — it’s WAY too late to pull out of the market now. The time to sell came and went along about last February.

If you sell now, you lock in losses, even if you are old and gray. Especially if you’re old and gray.

The likelihood that the market will regain my funds’ recent losses during my lifetime is nil. It will take 15 to 20 years for my assets to recover, just as it did the last time a steep drop occurred. If you have that much time left in your working life, you’ll be just fine. Keep on buying: now’s the time.

But if you take your money out and stick it into some 3% bank account, you never will recover the losses you’ve sustained in the past couple of weeks.

I’m going to take out enough cash to pay off the small loan against my house–about 10 grand–and let the rest sit. And retirement is now out: I will be working until I die in the traces. Assuming I can get work at all.

Writer's Coin October 10, 2008 at 7:19 am

Thanks for the link! I agree with most of what everyone else is saying here, but it’s amazing how much fear this is all creating. At least people are finally paying attention to their investments and the stock market in general. You don’t lose any money until you sell…

The Frugalista Files October 10, 2008 at 2:06 pm

I agree with writer’s coin. It’s when you want to sell that you run into a major problem. I’m no fan of this economy, but I am learning how to ride the storm.

old and poor October 19, 2008 at 2:36 am

If you are old and poor, why wouldn’t you try to get rich quick?

It’s not as if you have time to get rich slowly.

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