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Should I Get Out of the Stock Market

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The stock market has gone absolutely crazy.  I have had many people ask me over the last week or so if I am going to get out of the stock market.  The answer is definitely no!  Unless someone knows of a better way to build wealth long term, then I plan on staying in.

One of the statements I have heard too often lately is “I’ve lost all of my money in the market” or “I would have been better off burying my money in my backyard”.  Basically, the feeling for many is that they should have never put money in the stock market.  I would like to do some quick math and explain why I still believe it is the best long term strategy to building wealth.

Let’s take a look at a young, married 25 year old couple.  I generally teach young couples to start saving for retirement as soon as they can in order to make compound interest work for them.  The key is to be slow, steady and consistent.  Let’s pretend this couple took my advice 40 years ago, they’re now 65, and went through the recent stock market decline.    They had put $250 per month in mutual funds in the stock market for the last 40 years.

I will use the average rate of return for two of my mutual funds I own over the lifetime of the fund (roughly 12% at the end of July 2011.)  This couple would have had 2.9 million dollars at the end of July, dropping to 2.7 million with the market decline over the last week or so.  That’s right: 2.7 million dollars!  If instead, they had  buried the $250 per month in the backyard, they would have $120,000.  That is a 2.6 million dollar difference!

To summarize, let us think about this for a minute.  Would you rather have had 2.9 million dollars 2 weeks ago and lost $200,000 of it due to the market crash?  Or would you rather have “played it safe” and not lost a penny of your $120,000?

My overall point here is to not buy the hype of losing all of your money if you are in the stock market.  You may argue that I am using numbers over 40 years, which allows compound interest to work, so it is not fair.  But that is exactly the point: the stock market is a long-term investment.  It’s not something you use for a three year saving plan.  Remember, slow and steady wins the race.  If you keep that as your focus, you don’t have to stress out over what your investments are doing from day to day.

Matt’s note: If you’re very serious about an alternative investment you may want to consider investing in peer-to-peer loans as a way to diversify.

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Considering ETF Investing and Mutual Funds

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This is a guest post by Neal Frankle.  He blogs over at Wealth Pilgrim about how to find balance in your financial life.  When you finish reading, please consider signing up for his daily posts?

ETFs – better than mutual funds?

Mike Piper recently wrote a great piece on ETF investing right here at Debt Free Adventure.  In it, he did a super job explaining how they work and how they differ from index funds.  If you’re like me, you’ve been reading quite a bit lately about ETFs and why they are or are not better than mutual funds.

Mike makes the argument that since most mutual funds fail to outperform the index, you should buy the index – and the way for you to buy the index is to buy an ETF that matches the index as closely as possible.  Mike’s argument is very strong.  Having said that, I think there is a very important issue that often gets lost in this discussion.  As I see it, the “ETFs versus mutual funds” is a tactical issue.  An important tactical issue… but a tactical issue none-the-less.

What concerns me is that folks sometimes make dogmatic decisions about this (and other issues) and fail to consider strategy – and all the alternatives.  Here’s what I mean.  If your strategy is “buy and hold” – the argument to buy the least cost/better performing vehicle makes all the sense in the world; but what if you aren’t content to “buy and hold”?  What if you use a investment strategy like market timing? (Oh, I said it… “market timing”. Bad Pilgrim… very bad Pilgrim!)  Believe it or not there are market timing strategies that work.

A case for mutual funds over ETFs

There are millions of people who make money buying stocks – some of which are not buying and holding.  There are huge numbers of people who buy funds that are in (what they identify as) stronger areas of the market and refrain from investing in other areas that are weak.  There is evidence to support that this strategy can make sense for the right investor. It doesn’t work perfectly, nothing does… but it may be a better fit for investors who want to try to avoid some of the risk and are willing to give up some of the gains.  It would be silly for those using this strategy to ignore mutual funds and only use ETFs.  Why?  Let me give you an example…

One strategy ranks all the funds according to their short-term performance (1 year.)  This strategy doesn’t care about expenses, but is actually focused on performance.  Since performance is net of fees, it doesn’t really matter what the funds charge investors so long as, at the end of the day the performance is good.

You can see how using this strategy can make ignoring mutual funds outright a silly decision.

It’s sort of like the people who ran baseball in the 30’s and 40’s.  They ignored an entire population because of race considerations.  As soon as the sport welcomed African Americans on to the field, the performance sky rocketed.

What is your investment strategy?

Well… are you ignoring an entire population of funds at your own expense?  Do you struggle with the decision?  Do you dismiss mutual funds outright because of the expense and tax issue?  Let us know…