Don't buy low - You'll lose out? - Newbie

[Guest jbo]

At my job one of my coworkers was telling me that if your index funds go down in your 401k plan don't worry about it, becuase you are young and you will bounce back and when it goes back up you'll make more money, because you bought the shares when the price was low. I'm in my mid 20's so he told me that you should hope that it does bad, becuase you'll buy a lot of shares of it, so when it goes up you'll do so much better.

Now I talked to another coworker and he says that's not exaclty correct. He says for instance if you have 100k say in an index fun and it goes down 10%, well now it's at 90k. If it goes back up 10% you are still hurting, because 10% of 90 will bring you to 99k. So he says that buying when it's doing bad isn't a good idea.

Who's right?

[mbozek]

Look up "dollar cost averaging" on google-If you are purchasing shares with payroll contributions you will purchase more shares when the price declines so that you will have a larger account value when the price of the shares increases. If the dividends are reinvested then more shares will be purchased when the price declines. If FMV increase then fewer shares will be purchased with same amount of $.

example: 1 share @$10 fmv = 10 shares for $100 contribution. If fund declines to 9 then $100 will purchase 11.11 shares. If FMV of fund returns to 10 you own 21.11 shares with a fmv of $211.10

[Blinky the 3-eyed Fish]

They are saying two different things.

The first one's premise is that your index fund will be at X value at retirement no matter what happens now. The second one's premise is something different.

Obviously if the shares are low throughout and then the value springs up right before retirement to X you would own more shares than if the value was high and decreased to X before retirement. What the first guy is missing is that if the value is low, it may stay low.

[No Name]

Hope this formats correctly:

Year Buy Price Shares Total Shares Value

1 1000 20 50.0 50.0 1000.00

2 1000 19 52.6 102.6 1950.00

3 1000 18 55.6 158.2 2847.37

4 1000 17 58.8 217.0 3689.18

5 1000 16 62.5 279.5 4472.17

6 1000 15 66.7 346.2 5192.66

7 1000 14 71.4 417.6 5846.48

8 1000 13 76.9 494.5 6428.88

9 1000 12 83.3 577.9 6934.35

10 1000 11 90.9 668.8 7356.49

11 1000 10 100.0 768.8 7687.71

12 1000 11 90.9 859.7 9456.49

13 1000 12 83.3 943.0 11316.17

14 1000 13 76.9 1019.9 13259.18

15 1000 14 71.4 1091.4 15279.12

16 1000 15 66.7 1158.0 17370.48

17 1000 16 62.5 1220.5 19528.51

18 1000 17 58.8 1279.4 21749.05

19 1000 18 55.6 1334.9 24028.40

20 1000 19 52.6 1387.5 26363.31

21 1000 20 50.0 1437.5 28750.86

Total 21000

For over 20 years, I've made a "losing" investment, starting with a $20/share stock/mutual fund,etc. Saw it drop to $10, finally rebound back to $20.

Put in $21,000, have $28,751. Extreme example, but the math is there.

[Guest jbo]

Ok I guess one thing that confused me was that back in 2000 to 2002 a lot of people lost out and some of my coworkers lost close to 200k he told me and a few others lost a lot more. He told me that he shifted around this allocation, because it kept going down negative and negative. The other coworker said if this person would have just left it alone and then it bounces back then you are doing twice as well.

Let me see if I understand this correctly. Basically since you cannot add perentages together, if you own share and it goes down and then it goes back up it depends on when you buy it. What I mean is that when you buy the shares if it's low and then goes up you are doing better, but if you buy it and then it goes down and goes back up, eitherway when it went down it hurt you?

Basically what i'm getting at is if something happens like what happened to half of my coworkers in the years 2000 to 2002 what I should do? We have secure funds and I guess he is right and we should transfer over to the secure funds. I guess the smart thing to do is that while it's going down really bad to keep it at a secure fund and then while it's low is when you buy it back, so when it goes up the percentage you are better off.

I just know so many coworkers that told me they lost anywhere from 200 to half a million back in 2000 and 2002 and one guy was just telling me that he pulled everything out of the stocks and put it in these secure funds. I guess he did the wise thing? The one that thought it was smarter to keep buying the funds even though it was going down negative wasn't doing the correct thing, but it's better to secure the money in a more secure place and as it's going up is when to move the money back over?

Sorry for all the questions

thanks everybody for your help also

[MWeddell]

I say ignore them both. They are both right but it's just noise that distracts you from your goal of creating and sticking with a healthy retirement savings habit.

You are probably better off to just pick a lifecycle fund with a target maturity date close to the date you attain social security retirement age. Let the pros do your asset allocation and don't worry about what your co-workers say and don't worry about short-term fluctuations in your account balance.

If you want to make your own asset allocation decision, then some guidelines are

• Make sure you gradually decrease the percentage of your account invested in stocks beginning about 10 years before you hope to retire because the short-term risk starts to become more of a consideration then.
  
• If you are more than 10 years from retirement, then put the vast majority of your account in equities because the expected return is higher than cash or bonds
  
• About 20% of equities in international stock funds, 80% in domestic.
  
• Of your domestic equities, put the majority in large cap funds. Use an S&P 500 fund for your large cap portion of your portfolio because, there's usually one available in 401(k) plan investment line-ups, it'll prevent you from tilting toward growth or value too badly, many studies suggest that this is more likely to succeed than expecting whatever domestic large cap manager(s) you pick to outperform the index, and because you don't have to worry about monitoring your manager.
  
• Balance your small and mid cap domestic equity funds between growth and value. Co-workers who lost too much in 2000-02 probably were picking funds based on recent past returns and ending up with much more money in growth funds than in value funds.
  
• Don't invest any money in your employer's stock unless you are forced to do so. You've already got your career invested with that company. Use only diversified funds.
  
• Revisit your goals annually. Unless you are within 10 years of retirement, many years all you want to do is rebalance your account but keep the same asset allocation. Occasionally, if your plan offers more than one fund in an asset class, you may want to switch funds but this should be a rarity. Try not to be fickle.
  
• Keep on saving! Don't be discouraged by short-term results. Retirement savings is a marathon.
  

That's just my opinion. Free advice is usually worth what you paid for it.

[Guest jbo]

It just worries me about how so many people at my place of work tell me how they lost thousands and thousands I'm just seeing if history repeats itself which route am I better off. From what I was told was that for instance some people had 100% of their money in index fund that matches the performance of the S&P500.

The bottom line is if you look at the graph from S&P500 and you see when there were some years of trouble, would they have been better of from the begging pulling some of their money in other funds or continuing to invest in the falling fund, since it's return. I mean if you expect it to return the way it did, is it better to keep buying or pull out and then put it back in when the market seems to be more stable?

[Guest fatabbot]

It just worries me about how so many people at my place of work tell me how they lost thousands and thousands I'm just seeing if history repeats itself which route am I better off. From what I was told was that for instance some people had 100% of their money in index fund that matches the performance of the S&P500.

The bottom line is if you look at the graph from S&P500 and you see when there were some years of trouble, would they have been better of from the begging pulling some of their money in other funds or continuing to invest in the falling fund, since it's return. I mean if you expect it to return the way it did, is it better to keep buying or pull out and then put it back in when the market seems to be more stable?

jbo, it's really impossible to say. It's all really based on the future performance of the fund compared to an alternative. You shouldn't sell if that fund is going to perform well and bounce back. However, if the funds in a market (say IT) that won't bounce back any time soon, you might as well sell and reinvest it in one that will grow.

[MWeddell]

If you can tell that a fund is going to keep falling then you are better off to pull your money out of it and if you can tell that the fund has bottomed out and is going to rise then you are better off to move your money into it. Those are awful big ifs, aren't they? Just ignore the noise, jbo.

Your co-workers who had 100% of their accounts in the S&P 500 either have enough time to make up their losses or are close enough to retirement that they shouldn't have been 100% invested in equities. I continue to advocate that you ignore recent past performance when setting your asset allocation goals.

[RCK]

I really like MWeddell's 9 rules that summarize retirement investment strategy. I might argue some of the details, but as a package, it's a good set of rules.

I would add that I strongly support the rule about employer stock--it's a risk that you would not be compensated for taking. A lot of employees would feel guilty about not owning stock in their employer. If that applies to you, change the rule to

• Don't invest any RETIREMENT money in your employer's stock unless you are forced to do so. If you want to own employer stock, buy it through an Employee Stock Purchase Program.

RCK

[No Name]

I'm a little skeptical. In 25 years of accounting pension accounts, I've never seen someone lose Everything. Maybe all their gains, maybe (not unusual) some principal, but certainly not Everything.

If there are some horror stories out there, I'd like to hear them! Would make for a nice long-weekend read. (Of course, on the Business level, I've certainly seen some fish go belly-up).

[Guest jbo]

I read a lot of books and i'm always looking at the investing book section when I'm in the book store. I've read the book "rich dad poor dad" the orignal and I was looking at the shevle and he has so many other book. There's one book called "who took my money", so I flipped the book to read the back and it reads that between the year 2000 and 2003 investors lost between 7 to 9 trillion dollars in total. I didn't read the book, but just the back cover.

I actually don't know people who lost everything, but my coworkers tell me about other people who lost everything. We are a non-profit organization, so we don't have company stock.

What one of my coworkers was telling me was that it kept going down and going down and some of the other coworkers wouldn't move around the funds at all, they kept saying it's going to come back up and some lost hundreds of thousands of dollars.

I guess my question is that if I see funds going down one month, two months, three months or is there a certain time that you all would recommend that I move out the funds?

I believe I"m understanding it a little bit better. Basically if it keeps going down that keeps hearing me each month, but if I pull out the funds and say for some reason it starts going back up and I put the funds back in and it does nothing but increases I'm better off because I bought it when it was low. Buying low is great, when it goes up, but buying low when you stayed in the fund and loss money it's much harder to recover. Hopefully I got that right?

[Kirk Maldonado]

MWeddell:

I second the previous comments about the quality of the advice you provided above.

I have a question for you. When you say that a person should decrease their equity exposure as they are approaching retirement, are you contemplating that the person would be getting a lump sum distribution from the retirement plan? It seems like that is your assumption, but I'm not sure.

If the person plans on living for another 20 years after retirement and will have investment discretion over those amounts during that entire period, then it would seem that he or she need not start scaling down the equity investments ten years before retirement. Also, it would seem that he or she would want some amounts invested in equities for almost all of the period.

But I will freely admit that I'm not an investment wizard, except perhaps at finding flagrantly bad investments. So I could be way, way off base here. If I am, do not hesitate to point out the error of my ways.

[Kirk Maldonado]

I read an article once that supports the positions taken by mbozek and no name. The article downplayed the importance of marketing timing (meaning buying at the optimal price) by showing that even if the person invested in Fidelity Magellan Fund (back when it was a high-flyer), the person would have made money even if the bought it at the highest price each year, as long as he or she held onto the money.

As I mentioned earlier, I'm in no position to give others investment advice. I'm just repeating what I read in an article years ago. Whether the investment strategy of the author of that article is sound, is something to be decided by people with far more investment expertise than I possess.

[Guest jbo]

I see what your saying. I just read in a book I"m reading that there has been research and the average investor who invests in a mutual actually gets less return than what hte mutual fund returns, becuase they pull out and then get back trying to time the market.

I have coworkers who with their 401k plan buy and trade daily, but everything I read says that buying and holding you are better off.

From everything I've read they call it "average dollar cost" that if you invest 1k it's better to put the money in monthly instead of one large sum at once, becuase when it's lower you're buying more of it and it's not hurting you versus when you bought it and it went down. So then when it goes back up you're better off.

Basically with average dollar cost doing biweekly or monthly lowers your risk and increases your return if I'm not mistaken from what i"ve been reading. And therefore buying and holding and keep contributing you are better off than if you leave and then try to return.

[MWeddell]

jbo,

Buying low is of course a good thing to do. However, to determine at any point in time that one is "buying low" requires knowledge that a fund's value is going to rise in the near-term future. I believe that the typical retirement savings plan participant does not have this knowledge of the future and that in fact it is uncommon for anyone (not in the possession of material nonpublic information) to have that knowledge. Hence, I would not try to buy low.

To answer your question more directly, if you see funds going down for 1, 2, or 3 consecutive months, I would not typically suggest that you move money out of those funds. The reason is that any short-term past performance will only very rarely change one's long-term expectation of future performance. If your asset allocation was properly set before the fund started underperforming and your long-term goals and investment horizon haven't changed, then your asset allocation should change just because one of the funds underperformed (other than periodic rebalancing of your portfolio).

I continue to advocate that you ignore the noise from co-workers and, for that matter, much of the personal finance literature. If you are using diverified funds, not selecting individual stock, and you have a long investment horizon, then you really don't need to be worrying about your retirement savings investment strategy on such a frequent basis.

[MWeddell]

Kirk,

No, I do not intend to imply that one would take a lump sum distribution from the retirement plan. Even if one did take a lump sum distribution, most or all of it presumably would be rolled over. It would be fairly uncommon for someone to sell all retirement savings assets upon retiring (for example, someone who wanted to buy rental properties and live off of the rent during retirement years). Most retirees need to manage their assets for many years after retirement. Given that someone has lived to age 65, their life expectancy is at least 20 more years from that point.

However, I still believe that it is prudent to shift some (but by no means all) of one's retirement savings out of stock funds as one approaches retirement. One can quibble whether 10 years was the right rule of thumb, but the general concept is definitely right. First of all, because one is going to start spending one's retirement savings soon, one's investment horizon is becoming shorter and one rationally should start paying more attention to short-term risk. Second, many employees really will experience a significant loss of earning power upon retirement that should make them less able to tolerate short-term losses. If someone retires, experiences signficant short-term investment losses, and then decides to work for a few more years to make up for the losses, the retiree often cannot be reemployed at the same or higher compensation level that he (or she) previously had plus the risk of health problems that restricts one's earning power is growing. Even with a 20 year life expectancy, a retiree understandably should be more adverse to short-term risk and have a smaller percentage of his retirement savings in equities compared to an active employee more than 10 years from retirement.

Of course, when one is retired, hopefully one will have a large enough nestegg that it makes sense to purchase individualized investment advice from a fee-for-service financial planner. The guidelines I was proposing probably work better for active employees several years from retirement.

[Guest jbo]

MWeddell,

I was refering to people at my job who invested 100% in two mutual funds. For instance an one that follows the Dow Jones Wilshire 4500 Completion Index and one that follows the the S & P 500 Index, where the investments will cover the total united stock market. When I say Total United States Stock Market, this isn't my own words, but from my employeer.

I understand that you say there's no indication that it will go back up, but if it's the entire USA stock market isn't it resonable to presume that it will eventually go back up or we would go into a great depression and we would have to worry about our jobs more than what we are investing in?

[Kirk Maldonado]

MWeddell:

Thanks for clarifying that point. It was a question that had been nagging me. Your point is well taken.

JBO:

There is one case where I don't think that the concept of "dollar cost averaging" works. That is the following situation:

1. You currently have a large chunk of cash to invest, such as where you just got a large lump sum distribution of cash from a tax-qualified retirement plan, a lump sum payment of severance benefits, etc.; and

2. You are going to invest in equities; and

3. The stock market is on upward trend.

But as I've stated before, and has been already conclusively proven in this message thread, I'm the last person you should rely on for investment advice. In fact, I shouldn't even rely on my own investment advice.

Accordingly, I am very interested if others (especially MWeddell) agree or disagree with whether use of the dollar cost averaging approach makes sense in this particular factual situation. I will admit that it is predicated upon a bull stock market remaining in effect for the immediate future, which is difficult to predict, but for purposes of this hypothetical, assume it to be true.

[mbozek]

Dollar cost averaging is a technique to average the purchase price of investments over a time period to aviod buying at a peak price since no one can predict the top or the bottom of the market. Dollar cost averaging implies purchasing assets over a period of time and involves diversifing investments into different asset classes, such as large cap equities, small caps, equity index funds, stable value funds, bond funds, international funds, RE, etc. so as to avoid buying a single class of assets at a peak price. The alternatives to dollar cost averaging are market timing and stock picking which according to studies of investment returns account for only a small portion of the gains on investments.

[Guest jbo]

here's an article about it if anybody is intrested

http://beginnersinvest.about.com/cs/newinv...s/a/041901a.htm

[MWeddell]

I understand that you say there's no indication that it will go back up, but if it's the entire  USA stock market isn't it resonable to presume that it will eventually go back up or we would go into a great depression and we would have to worry about our jobs more than what we are investing in?

jbo,

No, I disagree. Let me illustrate with a recent example. In the middle of March 2000, many broad stock indices hit their all time highs but then started to drop sharply. By the end of March 2000, there were already some people who thought it was a buying opportunity. It was popular during the five preceding years to "buy on the dips," to believe that the general trend in the stock market was heading up so that any dips in stock prices were most likely temporary and were buying opportunities for so-called savvy investors. Increasing the percentage of one's portfolio invested in stocks at the end of March 2000 would not have been a fortuituous decision.

Especially with the S&P 500, which is a broad-based large cap U.S. stock index, the efficient market hypothesis is the strongest. If these is a general consensus that the index was likely to head up in the near future, then that expectation would already be reflected in the current price of the stocks in the index. I would be very skeptical of any claims that anyone can predict short-term movements in broad U.S. stock market indices even though one can read these claims all the time. Regard them as entertainment, not information that should impact one's investment strategy.

[MWeddell]

Accordingly, I am very interested if others (especially MWeddell) agree or disagree with whether use of the dollar cost averaging approach makes sense in this particular factual situation.[/i]

First of all, let me clarify that none of us is giving investment advice. I'm merely trying to provide broad guidance that may or may not apply in any particular individual's situation. Furthermore, I am not personally an investment professional.

Kirk, the whole concept of dollar cost averaging doesn't really apply to when one has a lump sum to invest. If, in your hypothetical, one insists on buying into the equity market gradually, this implies that the rest of the portfolio is left uninvested or invested only in cash. This is certain less than ideal, especially if you want to assume that there is a bull market, i.e. one in which stock prices are rising. In that case, dollar cost averaging won't work as well as investing completely when the lump sum becomes available.

[Guest jbo]

MWeddell are you saying that say somebody started off in 1999 with an investment that follows the S&P500 and invest 100% in only this fund. They drop say 3,000 dollars to get started and then biweekly they put in 100 dollars. Now in 2005 are you saying they are worst off than if they would have moved the funds to say some other securities and then back or were they better off leaving it?

I wasn't investing back in those days, so I only have people to ask questions and read, read and read. Am I wrong to assume that those that lost big time are the ones that pulled their money out and then when it was doing better put it back in? Those that saw 3 years of going down decided to pull their money out and then get back in?

I do see that the s&p 500 shows that the past 5 years performance has a return of around -2.5 give or take............. When it was negative for 3 years, what can you expect. But the over all question is that are you better off say in 2020 or years and years down the line if you never pulled out. I just figure you are better off, but I could be wrong if it does go back up. The reason being is that with dollar cost average with buying it lower when it returns you are making a bigger impact.

[MWeddell]

I am trying hard not to make any claim about when market timing will work and when it won't work. One can easily imagine scenarios when, with hindsight, it has worked and when it has not worked.

What I am trying to say is that if your asset allocation was properly determined, then recent short-term performance should not cause you to change your asset allocation. I can think of exceptions but that's the typical case. This assumes that one's investment goals and investment horizon haven't materially changed. Also, one should still periodically rebalance to one's target asset allocation.

[alanm]

Buying and holding is far from the sure thing it’s made out to be. It works in a bull market and it works if you invest regularly in drips and drabs. It works in mild bear markets, when declines quickly reverse like in 1987. It may work if you have twenty years to wait for stocks to recover from a half-off sale. Otherwise, it is risky: very risky if you bought high and extremely risky if you are planning to retire and take up golf within the next five to ten years. Nasty bear markets happen every six or seven years. Smaller declines of 10% or less, called corrections, happen about every two years-----some say we are in a correction now. Taken together, the minor and major setbacks have produced losses in thirty-one out of the last one hundred years. Although, statistics are like prisoners under torture: with the proper tools you can get them to confess anything. The bottom line...... if you are in the market you have risk, some can afford it, some can't. As Groucho Marx once said, after mortgaging his house to meet margin calls during the stock market crash in 1929, "I would have lost more, but I ran out of money."

[doombuggy]

Jbo, doesn't your retirement plan have an investment advisor you can speak to? If I have any questions about the market, I always ask my investment advisor. He was teh IA for the last company i worked for, but I still use him as a freelance (actually, he quit that place too and started his own firm). Even though I have been in this business since 1991, I am not an IA, and try not to give my opinion (even to my own self )

Bottom line is you need to speak to your plan's investment advisor, and not to your co-workers. The market isn't what it was in the 1980s or 1990s, nor is it what it was in September, 2001.