Lost Money In The Stock Market, What Should I Do?
In this Ask The Expert With Larry Swedroe article, the reader (Larry) lost a lot of money in the stock market. He detailed his plight and complained about his full service brokerage firm. It’s 2009 and he only have half of what he did a few months ago. What should he do? Here’s the question from Larry:
In June of 2008 my stock portfolio was worth around $800,000. Now it is around $400,000. I am freaking out. About $300,000 was evenly divided in Exxon and Chevron, which over the last 20 years have been a very good choice. The balance is with Merrill Lynch in their “Private Client” group. They had me in a fairly aggressive private fund that has lost around 44%. On top of the losses I will see capital gains in the fund and a stiff commission to Merrill.
I don’t expect you to say anything about them, but I will say they should have called me into their office with advice to rebalance my exposure in equities. Instead I got no advice. In my opinion, it is advice I pay for via a full commission broker service. What should I do? I feel like rolling everything from Merrill into a cash account until late ‘09. Suggestions are greatly appreciated. Thanks.
Answer From Larry Swedroe
Larry, sorry to hear about your situation, it is an all-too-common one. And in my opinion it happens because our education system has failed the public. Despite the fact that money is the third most important thing in our lives (after family and health), unless you get an MBA in finance it is likely you have never taken a single course in capital markets theory (and by the way, neither have most stock brokers whose investment education is mostly SALES training). And because Americans seem to be very lazy (they would rather watch some reality TV show than spend time reading books like my “Only Guides” series (equities, bonds and alternative investments). So that lack of education leaves them like sheep ready to be sheared by the wolves of Wall Street. It is usually the investment bankers that end up with the trips to Hawaii (financed by the fees paid by investors), not the investors. So my best advice is to get an education. You might start with my book Wise Investing Made Simple. It is a collection of 27 short stories that will give you an “MBA” in investing pretty quickly. At least you will understand the way the markets actually work and it will also provide you with the winning strategy.
In the meantime here are a few things you got wrong in my view.
- First, no one should own any individual stocks as that has more to do with speculating than investing because it involves taking what economists call unsystematic risk — risks that can be diversified away and thus you do not get rewarded for taking. Solution, build a globally diversified portfolio of passively managed funds like index funds and then stay the course, only rebalancing and tax loss managing. Several of my books show you how to do that.
- Second, my book on Alternative Investments shows the evidence on private equity and the results are not good. In aggregate, it is the purveyors that make the big returns, not the investors. And again it involves taking unsystematic risks.
- Third, your portfolio did not have sufficient diversification. And perhaps more importantly it may not have had even the right equity to fixed income allocation. My book The Only Guide to a Winning Investment Strategy You’ll Ever Need will help you understand the right way to invest and will also help you to develop your own Investment Policy Statement. It also explains why one should NEVER work with a commissioned investment advisor and also never work with an advisory who does not provide what is called a fiduciary standard of care. Both the “Winning Investment Strategy” and the Wise Investing books have sections on how to choose an advisor.
What amazes me is why anyone would trust their investments to a Wall Street firm. Haven’t they demonstrated that they cannot manage their own risks, let alone yours? And they really don’t have your interests at heart, they have theirs. That is why so few are willing to provide a fiduciary standard of care — because they would be required to provide advice that was in your best interests.
Here is a good question for you. In providing advice did the firm ever have a “discovery meeting” with you to find out your goals and ability, willingness and need to take risk? Did they explain fully the risks involved in investing in individual stocks and private funds? Did they show you the academic evidence on funds that try to beat the market (it is horrendous)? Did they write an investment plan for you? If none of the above was done then how could they give proper advice tailored to your situation? If there was no plan, how could they rebalance to targets that did not exist? My bet is they did not do even one of these things. The reason is that they are SALES people, not investment advisors.
Bottom line is the best recommendation I can make for you is to “invest” a bit of time and money in your own education. Reading books like the ones I have written will be the best investment of time and money you will ever make. Other authors I would recommend are John Bogle and William Bernstein. Good luck.
Disclaimer
- Mr. Swedroe’s opinions and comments expressed are his own, and may not accurately reflect those of the firm, nor Moolanomy and its owner.
- Not all questions will be answered
- By submitting a question, you grant us the right to publish your question.
- The answer is given based on the information provided in your question. Please seek professional assistance for more personalized advice.
This article was featured in the Carnival of Investing Strategies at The Penny Daily.
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Nice! Your articles are latest and informational. I always refer to your stock market guide. Thanks.
No one should own individual stocks? That’s an outrageous statement. One of Larry’s principle complaints was that his mutual fund suffered a crushing loss, and on top of that, he had to pay out taxes on capital gains. No individual stock issue will have this problem.
As long as you diversify within your individual stock holdings ( within reason, to keep commissions down ), you can achieve a similar low-risk scenario to a mutual fund, without the yearly fees and capital gains issues. Why in the world wouldn’t anyone want to own some individual securities in their portfolio?
On the other hand, Larry had too large of an exposure to oil stocks. That being said, he should DEFINITELY hold them, as oil will go back up, not if, but when. The fund, on the other hand… without knowing more about it… it’s hard to give advice.
A few comments about Rob’s post
First–from my book The Successful Investor Today:
Equity investors face several types of risk. First, there is the idiosyncratic risk of investing in stocks. Second, various asset classes carry different levels of risks. Large-cap stocks are less risky than small-cap stocks and glamour (growth) stocks are less risky than distressed (value) stocks. These first two risks cannot be diversified away. Thus investors must be compensated for taking them. The third type of equity risk is that of the individual company. The risks of individual stock ownership can easily be diversified away by owning passive asset class or index funds that basically own all the stocks in an entire asset class/index. Exchange-traded funds also can be used to accomplish this objective. Each of these vehicles eliminates the single-company risk in a low-cost and tax-efficient manner. Note that asset class risk can also be addressed by the building of a globally diversified portfolio, allocating funds across the various asset classes of domestic and international, large and small, value and growth, and even real estate and emerging markets. Individual investors can build portfolios that reflect their own unique ability, willingness, and need to take risk, tilting the portfolio to either higher or lower risk asset classes as best suits their personal investment plan. Since the risks of single-stock ownership can be diversified, the market does not compensate investors for taking that type of risk. This is why investing in individual companies is speculating, not investing. Investing means taking compensated risk. Speculating is taking uncompensated risk, like buying a lottery ticket.
The benefits of diversification are obvious and well-known. Diversification reduces the risk of underperformance. It also reduces the volatility and dispersion of returns without reducing expected returns, thus a diversified portfolio is considered to be more efficient than a concentrated portfolio.
The evidence on lack of diversification is particularly distressing given that changes in the equity markets have made diversification more important than ever. In December 1968, a study by John L. Evans and Stephen H. Archer concluded that an investor needed to construct a portfolio containing as few as fifteen randomly selected stocks before the benefits of diversification (as measured by standard deviation) were basically exhausted. A similar study from the same era found that 90 percent of the diversification benefit came from just sixteen stocks and 95 percent of the benefit could be captured by just thirty stocks.
Almost three decades later (1996), a study by two University of Nevada, Las Vegas, professors, Gerald Newbould and Percy Poon, came to a far different conclusion. They found that “investors needed to hold more than one hundred small-cap or large-cap stocks to remain within five percent of average risk, which they define as the average volatility of the forty thousand simulated portfolios created for the study.
Consider now an investor who wants to achieve broad global asset class diversification. He/she would need to hold over one hundred small-cap and one hundred large-cap stocks. And then the person would probably have to add a similar number of small- and large-value stocks, real estate stocks, foreign large-cap stocks, emerging-market stocks, etc. There is simply no way to achieve this type of diversification by building your own portfolio of individual stocks.
What has caused this increased need for diversification? A study, co-authored by Burton Malkiel, John Campbell, Yexiao Xu, and Martin Lettau, argues that a dramatic increase in the volatility of individual stocks, along with a declining correlation of stocks within the S&P 500 Index, has led to a significant increase in the number of securities needed to achieve the same level of portfolio risk. They found that for the two decades prior to 1985, in order to reduce excess standard deviation (a measure of diversifiable portfolio risk) to 10 percent, a portfolio would have had to consist of at least twenty stocks. From 1986 to 1997, that figure increased to fifty. Whereas the study found that there was a large increase in the volatility of individual stocks, the authors found no increase in overall market volatility or even industry volatility. The implication of the combination of increased volatility of individual stocks and unchanged volatility of the S&P 500 is that correlations between stocks have declined. Reduced correlation between stocks implies that the benefits of, and the need for, portfolio diversification have increased over time.
Second, with the advent of ETFs and Tax Managed funds investors can now invest in mutual funds in a highly tax efficient manner without giving up the benefits of diversification.
Third, as to Rob’s comment on oil stocks, nice to see how clear his crystal ball is that he emphatically states that oil stocks will in fact outperform a broader globally diversified portfolio to justify the risks of owning a concentration in one sector. My response to that is there are only three types of stock forecasters. There are those that don’t know how individual stocks will perform (include me in that group), those that don’t know they don’t know, and those that know they don’t know but get paid a lot of money to pretend they do.
The evidence from dozens of academic studies shows that there are no forecasters that persistently beat the market, beyond the randomly expected. For those that are interested in this subject I recommend William Sherden’s excellent book, The Fortune Sellers.
Fantastic article. I wish I had hundreds of thousands to invest. If I did though I wouldn’t keep most ofit in oil stocks.
He talks about financial advisers as being sales people, well I agree. He didn’t really give any advice except to read HIS books! There was much truth to his talk about financial advisers being salesmen, but yet he seems to be one too.
Sam
I did not give any advice? Did you even read what I wrote. I explained in great detail with evidence from academic papers why one should not own stocks. So my advice was to sell them
I explained the evidence on private equity and why one should not invest in it
Third I explained about how the portfolio was not sufficiently diversified. And thus there was a need to change that
Fourth, I advised about not working with a commissioned advisor because of conflicts of interest.
Fifth, I advised about the need for an investment policy statement and gave him the resources to help him write one
Six, I advised him to read some good books including those by other authors so that he could learn about the “science” of investing and become a more informed and thus better investor
I feel sorry for this guy I know how it feels. Big mistake on his part was dealing with Merrill Lynch. Has Merrill Lynch ever made anyone other then merrill executives any money I wonder. Their incompetence and greed has even caused them to blow up their own company so I wonder why anyone would give them a dime. Hopefully Larry makes some of his loses back and learns enough to stay away from the Merrill Lynch types or he will loose it again.