Five lessons from the stock market recovery
On Feb. 3, headlines read "Dow tumbles over 300 points." And with the Dow down more than 1,200 points for the year, many predicted a major market meltdown. But by last Friday, Feb. 14, the market was in a more loving mood and total U.S. stocks fully recovered. $10,000 invested in the Vanguard Total Stock Market Index ETF (VTI) was down $2.00, or 0.02 percent, with the broadest index, the Wilshire 5000 (full cap) up 0.03 percent for the year. The chart below shows the path to breakeven followed by some key investing lessons.
1. Put the crystal ball back in the closet. Many predicted stocks to continue to "plunge" in response to Fed stimulus being tapered or for a host of other reasons. Though to my knowledge no one predicted such a rapid recovery, there sure seemed to be a whole lot of people who seemed confident they could explain it.
2. Have some perspective. Sure the drop in stocks was painful, but words like "plunge" and "meltdown" make investors lose perspective. Stocks declined 5.44 percent after increasing by 213.77 percent from the March 9, 2009, market bottom.
3. Know who you are. What we lack in the ability to predict markets, we more than make up for in the ability to predict foolish investor behavior. Money only began flowing into stock funds beginning in 2013 when stocks hit an all-time high. According to the Investment Company Institute, funds flowed out of U.S. stock funds for the week ending Feb. 5. That week, Jason Zweig wrote a piece in The Wall Street Journal noting the stock market is the most expensive place to learn who you are.
4. The Dow isn't the stock market. While the stock market is flat for the year, the Dow is still down 422 points, or 2.55 percent. The Dow is comprised of only 30 stocks and the index excludes the dividends. In fact, only nine stocks comprise half the value of the index. Advisors love to measure their results against indexes like the Dow or S&P 500, which compares their total return to the part of the return of part of the market.
5. Stocks are riskier in a day than bonds are in a year. In 2013, the iShares Aggregate Bond Fund ETF (AGG) declined by 1.98 percent. On Feb. 3 of this year, stocks fell by 2.35 percent. Never forget that the role of your bonds is to act as shock absorber, so avoid low quality bonds or levered bond funds like the plague.
Just like no one knew stocks would recover so quickly, we also don't know whether the recovery is temporary or whether stocks will have another great year. The key to investing is learning to ignore both the media headlines and your instincts.