NEW YORK, NY (Nov. 29, 1999) -- I love writing on the Web. After every column, a number of people e-mail me -- some just saying thanks for an interesting article (hey, who doesn't like a pat on the back?), and others adding comments or disagreeing with me, mostly in a very thoughtful way. I enjoy and learn from the feedback, and it often provides grist for future columns -- like this one.

Last week's column on Warren Buffett's Prescient Market Calls triggered many e-mails (thank you!), mostly regarding my conclusion: "I have tremendous respect for Buffett's track record of accurate market calls. However, I have no plans to change my strategy of remaining fully invested. Why? Because despite the seeming accuracy of Buffett's market calls, every one of them has been wrong for the long-term investor." To support this, I presented data from Jeremy Siegel's Stocks for the Long Run and concluded with a quote from the book: "The upward movement of stock values over time overwhelms the short-term fluctuations in the market. There is no compelling reason for long-term investors to significantly reduce their stockholdings, no matter how high the market seems."

Given that by many measures the market has never been more richly valued, a recommendation to be fully invested at this time is hard to swallow, and a number of people e-mailed me to disagree. Since I do not believe that being fully invested at this time is appropriate for many -- perhaps even most -- people, I would like to explore this topic further and clarify what I meant in last week's column.

First, my recommendation that long-term investors be fully invested in equities is not rooted in a belief that the market will continue to soar. In fact, I am largely in agreement with Warren Buffett's prediction of single-digit returns for the next 17 years, as I discussed in my earlier columns.

Some other important issues related to the debate over being fully invested are captured well in this e-mail:

"I see no reason to risk a meltdown [of my portfolio]... by staying in a market which by almost any method of valuation is grossly overpriced. I have increasingly fallen out of love with stocks I used to treasure because of their marked increase in P/E, P/S, book value, and every other measurement I look at. I recently turned half of my portfolio into cash and I feel much more comfortable and secure now than I did two weeks ago, when it was 100% equities....

"How can you remain blind to the outrageous valuations we see in today's market? When someone with Warren Buffett's track record predicts abysmal returns over the next 17 years, I believe that it is time for someone like me, close to retirement, to heed his advice, preserve gains, and husband my funds, despite the superior record of equities over any 20-year period. In 20 years, I may be dead and I can't risk a single down year such as the one we lived through in 1973. A single major down year can play havoc with a retirement portfolio. A lot of other people in my age group can't risk such a downer. Your recommendation may be a huge disservice to people with sufficient funds to retire today, who may find themselves hurting and frightened about their future after a year or two of negative returns. What happened to prudence, caution, and common sense?"

I agree with many of these arguments. My belief that one should remain fully invested in equities is contingent upon three factors:
  1. The need to grow your wealth. If you are fortunate enough to have accumulated the money to achieve all your financial goals, then by all means take money off the table. Don't make the mistake that the managers of Long-Term Capital Management made (you may recall that this hedge fund, run by experienced investors and Nobel laureates who had all of their own money in the fund, imploded during the turmoil of August and September of 1998 because it leveraged its capital base up to 50x and then made a few bad bets). As Buffett commented at last year's Berkshire Hathaway annual meeting, "Why did they take the risk? They were already rich. There was no upside." My advice to be fully invested (but no more -- I don't recommend leverage to anyone) is aimed at the great majority of people who need to earn returns over time greater than those offered by bonds or T-bills to achieve their objectives.

  2. A long investment horizon. I do not have my entire net worth invested in stocks -- I have money set aside for the needs I anticipate over the next few years. I only advocate being fully invested with long-term money. What is long term? According to a chart based on actuarial tables published in Stocks for the Long Run, the average 60-year-old man who plans to retire at age 65 (that's early these days) and die with 50% of his assets remaining has a 16-year investment horizon. A comparable 60-year-old woman has a 19-year horizon. As a general rule of thumb, for every year that you're under 60, add a year to these figures. I would only suggest being fully invested if you have at least a 20-year investment horizon -- ideally 30 or more -- and have...

  3. The courage not to panic and sell in a down market. This is the tough one. Most people need to grow their wealth and have long investment horizons, but few have steely nerves when it comes to investing. As the e-mail above points out, most people would surely "find themselves hurting and frightened about their future after a year or two of negative returns" and be inclined to sell to prevent more pain. As another person wrote, "Time's healing ways may not be consoling if we suffer a serious loss." It's ironic, isn't it? At precisely the time when investors should be most eager to buy stocks -- when they've declined and are cheap -- investors are not interested. But when stocks are most richly valued -- leaving the smallest (or, some would argue, nonexistent) margin of safety -- investors can't buy stocks fast enough.
Would you have the courage to be a contrarian? Before you answer, consider humanity's propensity for self-deception -- a topic I addressed in a Bore report entitled The Perils of Investor Overconfidence. It's easy to say "I wouldn't be afraid and sell. I'd view a decline as a buying opportunity." But would you? Very few of today's investors can know for sure since the last sustained correction was so long ago. The best test I can think of -- though an inadequate one since the market's decline was relatively mild and the rebound quick -- was last year, when the major indices fell approximately 20% in six weeks from mid-July to the end of August. What were you doing during this time? Were you becoming more and more enthusiastic as stocks got cheaper and cheaper? Or were you miserable seeing the year's gains wiped out and selling -- or on the verge of doing so?

I'll leave you with those questions. Next week, I'll continue this discussion with more help from Siegel's book and your e-mails.

-- Whitney Tilson

Tilson appreciates your feedback at Tilsonfunds@aol.com. To read his previous guest columns in the Boring Port and other writings, click here.