Investing: Ride A Bull, Fend Off A Bear

By about this point, you are likely to begin running into columns online giving advice about what to do when the stock market enters yet another potential up year — it’s seventh since the lows of 2008 and early 2009.

Using phrases such as “fear an aging bull” and “bears throw in the towel,” the general purpose of these articles is to reassure market timers, those investors who think they know exactly which way the markets will go next.

Nobody knows. That’s the simple fact. It’s only in retrospect that people find their philosophical positions validated. Think back to all the weddings you’ve been to over the years. Now consider who is divorced and who is not.

Be honest, now. Some of the relationships you might have written off are going strong, while some of the “dream couples” we all knew broke up.

That’s the really interesting part about investing psychology. We are big into confirmation bias, evidence that things we already believe to be true must be true. If you’re a natural bull, a rising stock market proves your trust is well-placed.

If you’re more of a bear, well, seven years of rising stocks  is certainly a test of your patience. But it’s no proof of your wrongness, just of the level of delusion among others.

The middle ground feels like a weak choice. Our human nature, besides making us rampant devourers of any evidence we were right all along, also makes us want to pick a side. Luck favors the bold, right?

Yet the data shows how wrong that is. J.P. Morgan and market research firm Dalbar found that individual investors are absolutely terrible at picking sides. The average investor has a 20-year return of 2.5%, just a hair above inflation.

Bonds alone would have earned you 5.7% over that period, from 1994 through 2013, while the S&P 500 returned 9.2%.

Bull? Bear? It doesn’t matter at all. What matters is when do you need your money?

If the answer is “Oh, in about 20 years,” then you should own a portfolio that is mostly stocks, including foreign equities and emerging markets.

If you said something more like, “I think I need my retirement money in just a few years,” own a portfolio that is more conservative.

Risk tolerance

A well-designed portfolio that is matched to your risk tolerance and time horizon will inevitably capture most of the bull years while being conservatively invested later, when you can’t afford to lose too much.

Removing your emotions — and your reward-seeking brain — from the equation allows you to get a return close to the long-term return of the stock market while not taking on a huge amount of risk late in the game.

The secret is discipline, rebalancing and keeping an eye on cost. The mutual fund industry would like you to believe that it’s more complicated than that, but it’s just not. Ride a bull, fend off a bear and retire on time — it really is within your grasp.