Via Floyd Norris, we ran across a David Leonhardt column that made a point we've been making for several years: An investor's perspective on flat (or falling) asset prices is very much a function of his or her time horizon. It may seem counterintuitive, but investors who have any meaningful chunk of the accumulation phase (as distinct from the distribution phase) ahead of them should covet falling prices because they allow them to purchase the merchandise at a discount, which implies higher long-term returns.
After posting a pair of recent items (first here, then here) on the emotional whipsaws inherent in volatile market environments such as the current one, we think Leonhardt's column is especially timely. After all, if an investor is dollar-cost-averaging into a 401(k) on a monthly or biweekly basis, volatility--especially volatility with a bias toward lower prices--is just about the best formula one could cook up.
Here's Leonhardt:
Too often, we think about the economy without nuance. We treat it as a local sports team that is either winning or losing, up or down. We're always supposed to be rooting for stocks and homes to become more valuable and for oil and overseas vacations to become more affordable.
But that's not quite right. There are real downsides to an economy full of expensive assets and inexpensive resources. There are also a lot of people who are better off because of the recent turmoil. You may well be one of them.
The best place to start is the stock market, because it's the most counterintuitive. The notion that anybody but a sophisticated Wall Street short-seller should be hoping that stocks fall sounds, frankly, bizarre. But it's true: a huge chunk of the population--including most people under the age of 50--has benefited from this year's market drop.
My favorite explanation of this idea is still a column that Peter Coy of Business Week wrote in 1999, during the dot-com mania. He said he was thinking of forming a club called Stockholders Who Wish the Stock Market Would Stop Going Up So Fast. It would be meant for people who were at least two decades from retirement and who weren’t active investors. They instead owned 401(k)'s and individual retirement accounts.
They were, in other words, typical. Only 21 percent of families owned stocks outright in 2004, the most recent year for which the Federal Reserve has released data. Almost 50 percent of families owned a retirement account, by contrast. The typical retirement account (median value of $35,200) was also a lot bigger than the typical stock holding ($15,000).
These long-term, buy-and-hold investors, as Mr. Coy pointed out, are actually hurt by a market that rises too quickly. When stocks get so expensive, returns over the next few decades are usually mediocre. And only a small chunk of a typical person's investments will have been made before the run-up.
It would be much better--tens or even hundreds of thousands of dollars better--if the market rose more steadily and the bulk of the 401(k) contributions could then rise along with it. Buy low and sell high, right?
As we noted back in September, just before the Fed busted out with its 50-50 rate reduction, functioning markets sometimes produce falling asset prices. That's as it should be, as it always has been, and as it always will be. Disciplined investors will take advantage of the financial markets' periodic convulsions, deploying buying power when it's relatively advantageous. Those with shorter time horizons who can't tolerate near-term asset devaluation shouldn't be over-exposed to risky assets.
All of this is conceptually simple, but not emotionally or intuitively easy.
Source
David Leonhardt, "Good News: Housing's Down, Market's Off, Oil's Up," New York Times, November 14, 2007
