Some Terrible Advice I Hope You Ignore

Dick Bove -- bank analyst, frequent CNBC guest, and apparent purveyor of panic -- has some advice: Sell your stocks. All of them. Get out of the market. The debt ceiling debacle and its aftermath will be that bad.

"I'm basically asking people to get out of the market" he said on CNBC. "Get to liquidity. Put themselves in a position where they can be defensive."

Asked if his call is over the top, he fired back: "I definitely believe the sky is falling. You can call me Chicken Little if you'd like."  

Bove isn't just riled up over the debt ceiling. He thinks we're entering a phase where deep structural issues like global trade imbalances will start spinning in reverse. Deleveraging will go into overdrive. Currency debasing will come home to roost. "It seems to me that we've finally hit the point where we're going to have to come to grips with those issues," he said.

Let's put on our Mad Max hats and assume he's right. Assume the economy is about the implode. It rarely pays to bet against America -- but let's do it for now. Pretend things are about to get insane.

What should you do?

Do not follow Bove's advice. Do not sell everything and wait for the tide to turn. This is one of the biggest wealth-destroying traps you can fall victim to.

Some numbers for you to chew on: There have been 20,798 trading sessions between 1928 and today. During that time, the Dow went from 240 to 12,500, or an average annual growth rate of 5% (this doesn't include dividends).

If you missed just 20 of the best days during that period, annual returns fall to 2.6%. In other words, half of the compounded gains took place during 0.09% of days.

This isn't just true for long time frames. The market returned 12.9% in the 10 years ending in 2001, but miss the 20 best trading days during that period and you're down to less than 5%. The Dow squeaked out an annual gain of 2% over the past decade. Miss the 10 best trading days, and you're stuck with an annual loss of 4.6%.

The numbers couldn't be clearer: Missing just a few of the market's best days can derail long-term wealth accumulation.

And what's interesting about these "best" days? Every one took place during periods of utter market chaos. Of the 20 best days of all time, 17 were during the darkest days of the Great Depression. One was a few days after the crash of 1987. Two were during the depths of the recent financial crisis.

Sure: You can also say that if you missed the 20 worst trading days, your returns would be fantastic. It's true: From 1928-2011, a 5% annual buy-and-hold return jumps to 7.3% when you miss the 20 worst days. But what's interesting about these "bad" days? Most happened within spitting distance of the 20 "best" days. It's implausible to think anyone could have avoided the worst days and hit the best days without simply being lucky. It's literally in Monday, out Tuesday, back in Wednesday.

All of this drives home a tenet of investing and my beef with Bove's advice: You cannot time the market. Repeat that. Say it again. Tattoo it on your chest. This has always been true -- the world simply isn't predictable -- but it's more true today with the advent of high-speed computer trading and a proliferation of hedge funds. Try timing the market, and they will beat you every time.

So what should you be doing?

Buy companies when they're cheap and sell them when they're not. This has nothing to do with market timing. Buying a cheap company that takes years to turn a profit can still be an unqualified success. When Buffett bought Washington Post stock in 1973, it fell 20% and sat there for three years. He went on to make 127 times his money. Why? Because the company was cheap when he bought it. It didn't matter how long it took the market to figure that out. Sooner would have been better, but you simply never know beforehand. Buy cheap. Wait. Rinse. Repeat. It's the best recipe for long-term success.  

Maybe Bove thinks every stock is overvalued, but I doubt it. Large-cap tech stocks like Microsoft (Nasdaq: MSFT  ) , Apple (Nasdaq: AAPL  ) , Google (Nasdaq: GOOG  ) and Intel (NYSE: INTC  ) trade at some the lowest valuations in years, if not ever. Berkshire Hathaway's (NYSE: BRK-B  ) price-to-book value is the lowest it's been in decades. There are great companies trading at great prices. Stick with those. And turn off CNBC while you're at it.

Fool contributor Morgan Housel owns shares of Microsoft and Berkshire. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Apple, Berkshire Hathaway, Microsoft, and Google. The Fool owns shares of and has bought calls on Intel. Motley Fool newsletter services have recommended buying shares of Apple, Intel, Google, Microsoft, and Berkshire Hathaway. Motley Fool newsletter services have recommended creating a diagonal call position in Intel, as well as a covered collar position in Microsoft and a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. As you can plainly see, The Motley Fool has a disclosure policy.


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Comments from our Foolish Readers

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  • Report this Comment On July 29, 2011, at 2:19 PM, techy46 wrote:

    Missing a few dark days can also preserve capital to reinvest before the best days of the market. You can definitely anticpate many major events and ease off or push harder on the throttle. Rarely would you ever get entirely out and rarely would you be 110% in.

  • Report this Comment On July 29, 2011, at 2:26 PM, TMFHousel wrote:

    <<Missing a few dark days can also preserve capital to reinvest before the best days of the market.>>

    As the article notes, the best days are usually around the same time as the darkest days.

  • Report this Comment On July 29, 2011, at 3:47 PM, SkippyJohnJones wrote:

    I agree with your advice in general, but completely disagree with your 20 days argument. The article says not to panic and not to try timing purchases - great message. The stats on the 20 best and worst days is fun and amazing stuff to look at, but it in no way backs up your advice. If the 19 of the 20 worst days in the last 80+ years all occurred during TERRIBLE markets, investors would have been well served to "get to liquidity." They would have missed a lot more bad days than good ones, even if they don't make the all-time top 20 list. I'd love to see some data on compound returns from 1928-today, backing out 1929-1932 and 2008. Even if investors hadn't properly timed their withdrawals, they would have been miles ahead by sitting out the bulk of these periods.

    As an example, let's pretend someone liquidated their portfolio on 10/6/2008 and fully invested on 6/1/2009. This person would have sold AFTER seeing the DJIA drop by 30% from its 2007 all-time high, and more than 9% in the week leading up to the sale. They would have bought back in AFTER the market had already rallied off its March lows by 33%. (I feel like this is a realistic scenario, by no means the "in Monday, out Tuesday, back in Wednesday" suggested in this article.) This investor who gave up 30% on the way down and 33% on the way up would STILL be 14% ahead vs. holding through the market depths. Numbers below:

    14,165 (all time high) - 10/9/07

    10,851 (panic sets in!) - 9/30/08

    9,956 (liquidation) - 10/6/08

    6,547 (market bottom) - 3/9/09

    8,721 (resume position) - 6/1/09

    Even by missing the warning signs on the way down and being overly cautious on the way back up, this hypothetical investor would have gotten out at 9,956 and back in at 8,721. Sure, they would have missed a few dividends and paid transaction fees. But you can't possibly argue that staying the course would have been a better call than listening to your gut. The depression was a different story, as markets didn't have the liquidity we enjoy today. Getting in and out was much more difficult. But then, you're not writing to advise 1920's investors.

  • Report this Comment On July 29, 2011, at 3:48 PM, TMFHousel wrote:

    ^ That's still assuming you can time the market.

  • Report this Comment On July 29, 2011, at 4:02 PM, SkippyJohnJones wrote:

    It's not "timing the market" if an investor is looking at overwhelming macro and microeconomic data every day. For the sake of building a simple case study, you have to pick real dates and numbers. I'm not going to take the time to build a model involving a gradual move to cash and gradual move to equities, just as a comment on a TMF article.

    We can go back and forth, but this example happened pretty recently. It's not purely historical and academic in nature. We all went through the same anxiety, and everyone behaved differently. Of course few people went to cash on a single day or reinvested all at once. But the math would hold just as well with a gradual liquidation and a gradual reinvestment.

    My point is this: if you think the sky is falling, only you are responsible for what you do with your money. SOMETIMES it's ok to trust your instincts, even if the timing isn't exactly right. The market DID lose over half its value over an 18 month period before recovering. There was a very real reason for the dip, and it was on the evening news every night. Whether timed correctly or not, it's ok to get defensive. We don't all need to patiently sit in our stocks and funds and ride out every single market event. Generally it's prudent to hold on, but SOMETIMES there is a preponderance of evidence screaming "sell". I don't agree with Dick Bove that this is one of those times, but I wouldn't fault anyone who does.

  • Report this Comment On July 29, 2011, at 4:39 PM, Borbality wrote:

    Agree completely, especially for those of us with a long investing time frame or a lot of cash. Maybe not the best time to be in all stocks and close to retirement, but you never said it was.

    I think a lot of these media types are speaking more to the older investor who might not be sure what's going on with his or her 401k, and it's not bad advice depending on who he's speaking to.

    Have to disagree with those saying you can predict major events and trade based on that. The "end" of QE2 saw little to no movement in the markets and the Japan earthquake/tsunami actually saw the US markets have an UP day! It's just not that simple.

  • Report this Comment On July 29, 2011, at 4:59 PM, ebenh wrote:

    I love the wonderful example here of economists' conception of history: it started in 1928 and it is always constant(ly growing).

    The logic presented here is striking in its utter ridiculousness: History shows that nothing bad ever happens; wealth multiplies over time and this is a natural fact.

    There's an inability here to comprehend the possibility of an historical event actually happening--that is, something that comes along and produces something actually NEW in the situation. It is as if some people are so far inside the market and its carnivalesque logic that they have abandoned all hope of joining the rest of us back in the real world where things actually HAPPEN. You aren't actually taking your own advice far enough: "the world simply isn't predictable."

    "Buy low, sell high"? That's what you're still selling us? This late in the game? Could you offer a similarly obvious premise for the current situation we find ourselves in?

    Bah. I suppose I'm just preaching heresy to the choir here.

  • Report this Comment On July 29, 2011, at 6:44 PM, rfaramir wrote:

    This I don't understand at all: "global trade imbalances will start spinning in reverse"

    But staying out of the market during a time of volatility sounds okay to me. Especially if you think you are prone to making bad decisions under stress. Get out and reduce your stress.

    If you lose 2.6% (of 5%) missing the 20 best days and gain 2.3% (of 5%) missing the 20 worst days, AND those days are likely to be near each other, then you'd probably still have about 5% overall if you stay in the market most of the time except staying out of the market during high volatility.

    But better, IF you can stomach it, is to ride it out. Maybe have some cash to catch deals that irrational Mr. Market gives you. In fact, the more cash you have, the more you must have sold beforehand, the more coolly you can wait.

    Oh, and I wouldn't hold FRNs as all my cash. I'd buy some gold and silver. Some of the present volatility in particular revolves around the inability of fiat currency to hold value.

  • Report this Comment On July 29, 2011, at 7:54 PM, oprahbeau wrote:

    When Nixon ordered our monetary system to be changed, it was the beginning of the end. When currency is no longer backed by real money the inevitable happens...paper currency always but always collapses. To say that we should stay in the market because historic events have not affected stocks in the long run is naive at best. We are facing something that has never occured before...the demise of our currency. Since the 1970's it has been coming slowly but surely.

  • Report this Comment On July 29, 2011, at 8:52 PM, rando101 wrote:

    And where does Mr. Bove suggest you keep your cash for safe keeping after you sell all your stocks? Us Government Treasuries? FDIC Insured Banks? Bonds? Gold? Hide your dollars under your mattress?

    I would say all these "safe options" are just as risky as staying in the stock market now.

  • Report this Comment On July 30, 2011, at 11:56 AM, russfischer1013 wrote:

    Bove hasn't been right yet. Where does CNBC get these clowns?

    What is happening before our very eyes is a dramatic change in the way our federal government legislates to spend money. I would hate to be the US representative who tries to get a Bridge to Nowhere for his district the day after the debt ceiling crisis is solved.

    The first step is to STOP the crazy spending, the second step is to REDUCE the existing crazy spending (ethanol subsidy, etc??), the third step is to raise revenue where possible (dump the Bush tax cut), fourth is to pass a balanced budget amendment.

  • Report this Comment On July 30, 2011, at 12:17 PM, David369 wrote:

    See, that's the problem, people like russfischer1013 are not on the ballot when I get to vote. I always get to choose between bad and worst.

  • Report this Comment On July 30, 2011, at 1:46 PM, ajaykc wrote:

    Mr. Bove is the best timer of the market I have ever seen. I wasn't born during 1920 or anything. I have only two years of investing/trading experience.

    In 2010, around April, when BAC was at $18 and C was at $4 he was predicting that BAC will be at $26 and C will be $6 stock by year end. Year end passed and now you know where they are.

    You know his name and that's enough who he is and his knowledge. Market can go anywhere and nobody really knows.

    When 2011 started, it started with a bang and GDP 3-4% was predicted and now here we are at ~1.4%. That's all after easy money. Does anyone know where the market would have been without QE3. People blame Chinese companies for being corrupt and cooking the books what about US corporations. Plenty of them don't even pay taxes and whine all the time about high tax rates.

    Tax cuts create jobs, oh ya? Tea party/Republicans are creating millions of jobs every week and our unemployment rate is falling at a rapid rate. Lets cut more taxes and spending.

    If consumers don't spend, corporate profits fall and a country doesn't spend then its profit goes through roof?

    Tea party- a garage economist at best, is leading this country. God knows what happens next.

  • Report this Comment On July 30, 2011, at 1:47 PM, ajaykc wrote:

    Sorry about QE3, it should have been QE2.

  • Report this Comment On July 30, 2011, at 8:52 PM, techy46 wrote:

    Everybody's known that the QE2 ending and Debt Limit issue has been coming for months. It was quite easy to ease off in April, then ease of a little in the last two weks as each good stock reported earnings. By easing off start averaging into Calls far enough out, Oct and Jan, and preserve capital by selling the underlying stock. Monday and all next week will probably be time to keep avering the calls lower. When the market turns average abck into stock selling calls. The best days do not occur until the market capitulates to the reality which may be next Monday, Tuesday or Weds or latter if they keep kicking the can.

  • Report this Comment On July 31, 2011, at 1:37 AM, strummin wrote:

    what would warren buffet do?

  • Report this Comment On July 31, 2011, at 6:34 AM, RPRogers wrote:

    HI

    Can anyone tell me where to put cash that was received a week ago? Right now I do not want it in a money market, cd's ,bank securities, t-bills, or a bank. How is money held in a brokerage account?

    I'm fairly new to investing in a IRA instead of a 401K.

    Appreciate it if some of your bright minds would help me out.

  • Report this Comment On July 31, 2011, at 2:40 PM, pscholte wrote:

    While I have heard this argument many times, this smacks of a self-serving article by someone who works for an organization that makes its best money when people are actively investing and looking to them for advice. Bove may be out in left field but I don't trust Housel's argument either. Honestly, I KNEW what this article was going to be about before I clicked on it.

  • Report this Comment On July 31, 2011, at 2:43 PM, pscholte wrote:

    PS This argument assumes it will NEVER be different this time...just remember past performance is no guarantee of future returns.

  • Report this Comment On July 31, 2011, at 3:06 PM, vidar712 wrote:

    @RPRogers

    Burn it. It is the only way to know for sure that your money can't lose any more of its value.

    Scottrade holds your cash in a money market account.

    You should dump all of your money in an index fund with low fees and not worry about it.

  • Report this Comment On July 31, 2011, at 5:43 PM, pscholte wrote:

    "Bove hasn't been right yet." It takes a clown to make a stupid statement like that. Financial advisors who have NEVER been right probably NEVER get invited back. What a dumb comment!

  • Report this Comment On July 31, 2011, at 8:36 PM, HectorLemans wrote:

    The "just so" story SkippyJohnJones offers for why market timing works is extremely seductive but wrong.

    "This person would have sold AFTER seeing the DJIA drop by 30% from its 2007 all-time high"

    I believe the definition of a bear market is a drop of 20%, so why would one sell towards the bottom of one?

    "They would have bought back in AFTER the market had already rallied off its March lows by 33%"

    And why would one not assume this was a dead cat bounce, like all the others before?

  • Report this Comment On August 01, 2011, at 11:19 AM, SkippyJohnJones wrote:

    @ Hector Lemans, of course my scenario was "just so." That was deliberate. A far more realistic approach would have been along the lines of @Techy46's comments. It would involve gradually doing any or all of the following: buying downside protection, buying commodities to hedge, outright selling of stocks, shifting into emerging markets, buying bond funds, etc. As investors grow gradually confident that the market is not seeing a dead cat bounce, they slowly reverse these actions and begin to chase growth to replace lost capital. Unfortunately, I don't have the skills or the time to model what such actions would have looked like in the 2008 market crash and subsequent market rally.

    My intention was to show that it isn't evil to sell when the sky is falling. Sometimes really bad things happen in the world and affect the markets in drastic ways. I chose the down 30%, up 33% BECAUSE theory and historical economic data would suggest that these were both terrible decisions. In real world, an actual credit/housing/employment/fiscal crisis trumped all theory. The market actually rewarded investors who simply went with instincts.

    "I believe the definition of a bear market is a drop of 20%, so why would one sell towards the bottom of one?" - because definitions are useless. The definition of a recession is consecutive quarters of negative growth; the whole world knew with certainty that we had entered a recession months before economists could state the obvious with hard numbers.

    "And why would one not assume this was a dead cat bounce, like all the others before?" - because earnings were starting to roll in. Actual results were driving the bounce. But even if you don't like my reentry point, pick a better one. The market didn't get back to my (arbitrarily chosen) selling point of 9,956 until November. If you were still thinking dead cat 8 months into a steady rally of over 50%, you are paranoid and shouldn't be an equity investor. Outside of the paltry 2009 dividends and a few transaction fees, investors would have been allowed to sit out more than a year of mind-bending turbulence without penalty.

  • Report this Comment On August 02, 2011, at 9:58 AM, FutureMonkey wrote:

    ****cough****modernportfoliotheory***clearsthroat***

  • Report this Comment On August 04, 2011, at 4:58 PM, agitatedString wrote:

    HectorLemans wrote: "I believe the definition of a bear market is a drop of 20%, so why would one sell towards the bottom of one?"

    Whew! Who/What/Where/When/How defined "bear market" for Hector ? Hector perhaps you should look again at whatever SkippyJohnJones wrote and ask yourself what about it and why it prompted any sort of emotive response on your part. Getting hung up on word definitions is going to seriously hinder your ability to respond nimbly in a volatile and shifting market.

  • Report this Comment On August 04, 2011, at 7:08 PM, HectorLemans wrote:

    @agitatedString: I didn't define it - it's a generally agreed upon definition. See http://en.wikipedia.org/wiki/Market_trend#Bear_market

    It's just a definition, no more / no less. The overall point I was trying to make was how arbitrary SkippyJohnJones' example was. I'm not trying to attack him - just want to point out that humans have a tendency to remember history in a way that is convenient to them and leave out all the details. Usually that's not a bad thing (it helps us remember the important stuff), but in investing, it can kill you because you have to react to the real world - not your interpretation of it.

  • Report this Comment On August 05, 2011, at 12:08 PM, troym72 wrote:

    You're not going to hit the top and you're not going to hit the bottom. Your goal is to simply make a living in the middle. Spot a trend and stay in it until it breaks. If you try to time the market you're going to get your face ripped off. Just trade the trends and don't try to be a hero.

    - Jeff Macke -

    I think this is great advice.

  • Report this Comment On August 05, 2011, at 12:27 PM, mtf00l wrote:

    I bought the dip and it's still dipping...

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