The Duty of an Investor

Observations on the collapse in stock prices

By Kaye A. Thomas
Posted October 10, 2008

Lots of selling? There is just as much buying.

Inhale. Exhale. That's the idea. A couple more times. Okay, let's talk about the stock market.

All that selling

We keep hearing on the news that stock prices are falling because people are selling. You can't sell shares, though, unless someone else is willing to buy them. In the stock market, the number of shares sold is stubbornly equal to the number of shares purchased.

Does it make sense to sell at this point? Here's a quote from John Maynard Keynes, an influential economist who was also a highly successful investor and thoughtful observer of the stock market:

I do not feel that selling at very low prices is a remedy for having failed to sell at high ones.

No doubt there are some people for whom it makes sense to get out of the market now, but they are precisely the ones who should not have been in the stock market in the first place.

The duty of an investor

Did you make a mistake by having money in the stock market while this was happening? Did your advisor make a mistake by failing to warn you to get your money out?

No and no. If there were some way of knowing the market would fall from a high of around 14,000 to a level below 9,000, it wouldn't have been at 14,000 in the first place. Don't beat yourself up over failing to predict something that's inherently unpredictable. The same goes for your advisor. Here's another observation from John Maynard Keynes:

I would say that it is from time to time the duty of the serious investor to accept the depreciation of his holdings with equanimity and without reproaching himself.

The real mistakes

That isn't to say people aren't being hurt by their own mistakes, or mistakes of their advisors. A sound investment doesn't shield you from losses but it limits the damage. You would be down about 30% from a year ago with the simple approach of putting 75% of your money in a good index fund and 25% in bonds (based on the market being down about 40% and bonds roughly breaking even). It's reasonable to accept — with equanimity and without reproaching yourself or your advisor — a somewhat larger loss in a portfolio built on the notion that you would accept greater risk for a shot at higher returns. If you've lost a lot more than that at this point, though, it's a good bet there was something lacking in your diversification or asset allocation. And if you've had substantial losses in an account that represents money you'll need to use within the next few years, you're getting a hard lesson in why the stock market isn't suitable as a short-term investment.

The falling knife

Does it make sense to buy stocks at today's lower prices? The cliché answer is that this is like trying to catch a falling knife. (A search of for this phrase in Google News showed it appearing 367 times; in the Web overall it appears about 136,000 times.) You'll hear this from many of the same people who say you shouldn't be selling if you're already invested. Stocks are too risky to buy, but not too risky to hold, they seem to be saying.

Certainly no one should expect to time a new investment at the exact bottom of the market. Some people will manage to do that, but it will be luck, not brilliant analysis, that brought them in on that day. Certainly also anyone investing at this time will be exposed to the same extreme volatility that's buffeting people who are already invested. Yet neither of these points should discourage anyone from making a prudent, well-diversified long-term investment in the stock market. If it's okay to hold on in these market conditions (and it is okay to do that) then it's okay to buy. If you have a long enough time horizon and the temperament to tough it out while stocks gyrate, there's nothing inherently unwise in buying stocks during this period of turbulence.

Five percenters

We've seen large percentage moves in the stock market on a number of days recently. For context, Jeremy Siegel notes in his book Stocks for the Long Run that in the period from 1885 through 2006 there were just 126 days when the Dow Jones Industrial Average changed by 5% or more. Nearly two-thirds of those days occurred during the market turmoil of 1929 through 1933, and we've gone as long as 17 years between two such sharp moves. We are truly in a period of historically high stock market volatility.

It's worth noting that these sharp moves are not all on the downside. Almost as many have been increases, and the biggest gains often come shortly after the biggest losses. People who bail out at the low prices produced by a steep decline don't participate in the equally sharp recovery that may be around the corner.