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March 26, 2009

Battle plan for reinvestment

I see some familiar thoughts expressed in this interview with Jeremy Grantham:

Grantham recommends that each of us devise a detailed plan now of when we will put new money into the stock market: "You absolutely must have a battle plan for reinvestment and stick to it."
A corollary of this recommendation is that we accept that we won't catch the exact day of the bottom. Perfection is the enemy of the good here, since the pursuit of perfection actually is a "snare and a delusion: it will merely serve to increase your paralysis.

One of the biggest concerns I had in writing this month's cover article is that it might lead some readers to act defensively here (i.e., sell stocks), only to then have them stay fearfully on the sidelines until stock prices were much higher at some point in the future. While it may feel good to reduce your stock market exposure during a bear market, you obviously aren't being well served by selling at Dow 7,500 and buying back in at Dow 9,000.

That's why I tried to emphasize that anyone doing any selling this late in the bear market should establish up front a trigger for getting back into the market. The all-clear signal is a good tool, but slow. It's probably more appropriate for those who reduced their stock allocations way back in January 2008 when the bear-alert was triggered.

For those making adjustments now, a better approach is probably to draw a "line in the sand." The line in the sand approach is to simply pick some level around the point at which you sell that will force you back into stocks. For example, if you sell at Dow 7,500 you might resolve to buy back in if the market should move above Dow 8,000. (You could simply draw your line at the level at which you sell, except that a quick move above that point could whipsaw you into buying immediately after selling. So it's probably smart to build in a margin of at least a few percent to avoid that.)

Anyone who reduced stock exposure earlier in this bear market should also be going through mental exercise of determining what will cause you to get back into stocks. You may have made a brilliant move by getting out a year ago, but you need to follow that up with an intelligent decision of when to re-enter.

I'm not oblivious to the recent market conditions, and I recognize that most readers probably aren't inclined to take defensive actions fresh on the heels of a 20% spike in stock prices. Nor am I encouraging them to! Truth be told, my preference for the cover article would have been to just write "Hold on, you're probably better off not selling anything this late in the bear market." But that would have ignored the fact that just three short weeks ago, many investors were throwing in the towel. It's not a stretch to think that a couple of weeks of sharp losses would bring many investors right back to that point.

So, if you were one of those who, just a few weeks ago, were seriously questioning whether you should sell some of your stock holdings, you need to take advantage of the oxygen provided by the recent gains. Those gains help give you the ability to think more clearly and rationally about what your best approach will be IF this turns out to be a bear market rally and things start heading south again. If you think through the mental exercise now while your head is unclouded by fear, you'll probably make a better decision than if you wait until the market is retesting the early-March lows.

Of course, we can all relax if the market keeps going up, up, and away. But better to be prepared and not need that contingency plan than to need it and not have it.