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Plan Not to Panic

Joel Greenblatt, March 08, 2010

The dark shadows of 2008 still remain in 2010 and are having a deep impact on the way people are investing (or rather non-investing) today. Most investors did not expect and certainly didn't plan for a stock market drop of almost 40%. As painful as this experience was for many people, it's already in the history books and what's more important now is to learn something valuable from the experience. In fact, if your investment horizon is the next 10 or 20 years, this lesson could change your life (or at least your retirement!).

To keep the lesson short, here's what I think you should take away from the experience. An investment strategy where 100% of your assets are invested in the stock market (even with no leverage/margin account, etc) can result in a drop of 40% or more in your net worth in any particular year (duh, you're probably thinking). But that's so important to know (and plan for!). If you can't live with a drop of that size, you can't put all your money in the market. You'll likely panic out or be forced to sell at exactly the wrong time. In fact, if we start with the premise that you can't handle a 40% drop, then putting 100% of your money in the market is a strategy that is almost guaranteed to fail at some inopportune time down the road!

So, what should you do? The answer is annoyingly simple. I believe the stock market is a great place to make money over the long term. Despite the last decade's poor returns for the broad market averages (and including the knowledge that you are not forced to buy the average stock, but can follow a strategy like Formula Investing to buy a portfolio of above average companies at below average prices), I firmly believe almost everyone should have a significant portion of their assets in stocks. But here it comes-Few people should put ALL their money in stocks. Whether you choose to place 90% of your assets or 40% of your assets in stocks should be based largely on how much pain you can take on the downside. As painful as it might be, if you put only 40% of your money in stocks and the market falls 40%, the simple math says you'll only be down 16% (though it depends on where the rest of your assets were at the time!)

However, and most importantly, once you've chosen an amount you can handle, every time the market drops, hopefully you will no longer be tempted to sell all your stocks, put on your feety pajamas and roll up into a little ball. Over the long term, despite significant drops from time to time, stocks (especially an intelligently selected stock portfolio) will be one of your best investment options. The trick is to GET to the long term. Think in terms of 5 years, 10 years and longer. Do your planning and asset allocation ahead of time. Choose a portion of your assets to invest in the stock market-and stick with it! Yes, the bad times will come, but over the truly long term, the good times will win out-and I hope the lessons from 2008 will help get you there to enjoy them.

Past performance is not indicative of future results. This is not a recommendation to purchase or sell any particular security. There is no guarantee that the strategies discussed will prove to be profitable. Formula Investing reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. It should not be assumed that any of the strategies discussed will prove to be profitable, or that the investment recommendations or decisions made in the future will be profitable. Investing in the stock market carries significant risk, including the risk of loss of all or a substantial portion of the amount invested.

Formula is a term used to describe the investment strategy explained in The Little Book That Beats the Market. The use of the formula does not guarantee performance or investment success. Formula Investing is a separate legal entity from MagicFormulaInvesting.com and is separately operated; however, both Formula Investing and MagicFormulaInvesting.com are owned in part by Joel Greenblatt. Joel Greenblatt does not serve as the portfolio manager at Formula Investing.

Formula Investing, LLC is a registered investment advisor. A copy of Formula Investing's Form ADV disclosure document is available upon request. More information about the about the advisor including its investment strategies and objectives can be obtained by visiting http://www.formulainvesting.com/. FI-10-12

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The Essays of Warren Buffett: Lessons for Investors and Managers by Lawrence A. Cunningham	The Definitive Book on Value Investing. A Book of Practical Counsel by Benjamin Graham	Moneyball by Michael Lewis	"The Invisible Heart: An Economic Romance" by Russell Roberts