There are two silent killers of your investment account lurking. How will you deal with them? These silent killers are not a lousy broker, or rising interest rates, or poor earnings from companies you invest in. Its not even the media. The first silent killer in your account is inflation. Inflation (or deflation) or better yet, lets call it price instability, is the universal ignition switch for bear markets. Too many in the market get wrapped up in pointing fingers at housing starts, interest rates, the latest scandal, poor earnings or some political event as the cause for a bear market. Price instability (whether it is inflation or deflation) has wiped out many investors. Now, another way of saying we have price stability in our economy is to say we have relatively mild or low inflation. This is important: that stability allows the Price/Earnings Ratio (or P/E) to expand. This is really important to understanding WHY we have bull and bear markets! Now, many folks in the market often refer to the P/E ratio as a yardstick to determine whether a stock (or the market in general) is overvalued or undervalued. Now, why am I talking about P/E ratios? Well, you need to know this: Bull markets start with very low P/E ratios. I mean REALLY low P/E ratios. And know this, too: bull markets end with very high P/E ratios. Ok, so weve talked about P/E ratios and bull markets. Great. So then why is the title of this article talking about silent killers? Because we are now in a phase of price instability, and increasing inflation. We are seeing signs of inflation and price instability all around us. Usually when we have these signals, the stock market has problems. But look, dont get hung up on P/E ratios and math. Just remember this: when we have higher than normal inflation, P/E ratios contract. And when P/E ratios are getting smaller (contracting), its going to be tough to make money in the market. I said tough but not impossible. You cant take your boat out to the middle of the lake and just expect the fish to jump into the boat for you. You need to do some work. Not coincidentally, the market has remained stagnant the past few years. In many markets, we are in roughly the same place where we stood five or six years ago. Except now we have increased inflation. Oh and theres more... Many (but not all) bear markets end with the market averages in roughly the same spot they began. After several violent years of market action (up and down), there seems to be no movement in the big picture. But remember, the major market averages often complete a bear market in the same spot...NOT your mutual funds and stocks! They get destroyed! Which is why I started this article with the phrase: silent killers! So, the second silent killer in your investment account is: ourselves! I should say our own apathy. Its just too easy for us to see a stock or mutual fund in our account thats not keeping up with the market and tell ourselves to give it a little longer or I cant sell that...its a core holding! Hogwash. There should be no such thing as a core holding. If it is not performing, you need to examine why you are holding the fund or the stock. So many folks in the market will wake up, like Rip Van Winkle, a few years down the road and discover that we have been in a bear market since 2000. They should have been doing a better job managing the risk in their account. They should be pruning the non-performing assets and focusing on sectors that are doing well. And they will also learn that diversifying their assets in too many directions according to some pie chart they got for free will only serve to water down great returns they achieved in one sector. Money can be made in sideways, and even down markets. But using a buy and hold approach is definitely NOT the way to do it. |
