The market's crashing! What should you do now? Um, nothing.

How to lose your money fast.
March 6 2007 6:33 PM

The Market's Crashing! What Should You Do Now?

Um, nothing.

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Last week's mini-plunge produced the expected blizzard of stories on the theme: "The Market's Crashing! What Should You Do Now???" The implication, of course, is that smart investors should pay close attention to what the market is doing and adjust their strategies accordingly. Nothing could be further from the truth.

Let's consider the Wall Street Journal's version of this bad-advice staple. It kicked off with the predictable lead—"What should you do now?"—then painted a picture of busy experts adjusting to the new world: "On the heels of a difficult week for stocks, highlighted by Tuesday's dramatic 416-point decline in the Dow Jones Industrial Average, investors are revisiting their portfolios, and top financial advisers and analysts are mapping out strategies for clients."

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Like other stories in this genre—"The market's soaring; what should you do now?" "The market's drifting; what should you do now?"—the post-crash strategy review makes for great investment media. Who wouldn't want to read a story or watch a show purporting to know what everyone should do now?  What makes great investment media, however, often makes terrible investment advice.

To the Journal's credit, its story did contain a lot of smart advice. The writers noted "the folly of trying to time the market" and cited work by the Hulbert Financial Digest showing that "even experts get [market timing] wrong." Unfortunately, as usual, these sage comments were blended with suggestions that readers react to the sell-off by buying "high-quality stocks" and paring back risky investments like emerging-market stocks. In other words, the Journal advised readers against reacting to market events, then told them how to react.

Readers of this column will already know why this is bad advice:

  • No one but Nostradamus knows what the market is going to do. Last week's sell-off does not make it any more or less likely that the market is going to go up or down this week (or, for that matter, this year).
  • No one but Nostradamus can time the market consistently. If you knew the market was going to crash, the answer to "What should you do now?" would be obvious: Short the world. Alas, numerous academic studies have shown that successful market-timers are, at best, an extremely rare breed.
  • If it really matters to you what the market does in the next several months or years, you shouldn't own stocks. Sorry to alarm you, but stocks are a very risky investment over periods of less than five to 10 years, no matter what the market is doing. If you need your money before then, you shouldn't have it in stocks.
  • The last thing you should base your investment strategy on is what the market has done. One of the most common and most devastating mistakes investors make is "driving with the rearview mirror," as Warren Buffett puts it. Specifically, they buy investments that have done well and sell those that have done badly. Although this strategy feels comfortable, it is idiotic.

Could last week's downturn turn out to be the start of a multiyear crash? Yes. Could it also be a head-fake that, with the help of articles titled "What Should You Do Now?" scares you into changing strategies, paying unnecessary taxes and brokerage commissions, and, worse, missing additional gains? Yes. The only thing you can be reasonably certain of is that, if you have an appropriately long-term time horizon and an appropriately diversified portfolio, what the market does in the next few months or years won't matter a bit.

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