NEW YORK, NY (Dec. 6, 1999) -- At the end of last week's column, I suggested that you should not be fully invested unless you have "the courage not to panic and sell in a down market." Frankly, the history of the stock market and investor behavior does not give me much comfort that many investors pass this test. Someone who e-mailed me makes the point quite eloquently:

"The common wisdom of today suggests the best way to invest for the long term is simply to put your money in stocks and leave it there -- the buy/hold approach. The point that I dispute is that while stocks have long demonstrated their ability to outperform bonds, Treasury notes, and other fixed income securities over the long term, the market's long-term 'superior' performance frequently has included painful corrections, significant bear markets, and extended stretches of quite meager returns.

"For example, from January 1960 through December 1974 the total annualized return of large-cap U.S. stocks was only 4.3%. More recently, during the 15 years from August 1967 to July 1982, the total annualized return of the S&P 500 was only 5.1%.... Staying fully invested in stocks for those periods was not very rewarding. I ought to know, because I spent most of those time periods trying to convince the public that stocks were the way to go.

"You may very well stay invested in stocks for the next 25 years. But I can say with a good deal of confidence based upon years of observing stock market psychology (I became a stockbroker in mid-1965, and my training came at the hands of my father, who became a stockbroker in 1926), that the majority of today's stock investors won't. The minute that the returns sluff off, CDs and other alternatives will look more and more desirable. Nevertheless, that doesn't in any way diminish your laudable efforts to educate the public to the merits of a buy-and-hold strategy. It's just that in all fairness, you should present the whole picture of the stock market, not just one segment of it. Owning even good stocks can be very painful at times (I believe it's called risk)."

Hear, hear! If you're not certain that you have the courage to sit tight (or better yet, buy) during a severe, sustained bear market, then you should not be fully invested, especially at today's valuation levels. A sure route to awful returns is being fully invested at market peaks and then selling and sitting on cash during market troughs. Incidentally, this is precisely the behavior of mutual funds -- yet another reason to invest in index funds. According to a study cited by John Bogle of Vanguard, at market peaks mutual funds held only 4% of their assets in cash, but during market troughs they held 14% cash -- precisely the opposite of what one would desire.

Another professional investment adviser with more than 20 years of experience made similar points about investor behavior and proposed a different definition of fully invested:

"Most investors today have no clue how bad it can get and I am not talking about losing money. Most investors don't understand how their bankers will react to a lower net worth on their balance sheet. Most investors don't understand that debt as a percentage of assets grows when stocks lose value (a definite formula for lost sleep). Most investors won't invest when things are bad, while share prices are dropping, when actually they need to be investing the most. Most investors have no idea what it is like to have a plan for the future implode... due to earning less (or nothing) over a crappy 10-year period in the market. Most investors don't have a plan or a discipline at all.

"Fully invested means being invested fully to the degree necessary to meet your long-term goals. No more! No less! Said even simpler: If your portfolio requires 'only 30%' of your assets be exposed to variable assets (stocks) to meet your return objectives, then that is fully invested. Rebalancing takes place as one area (stocks, bonds, or other assets) becomes overweighted in the portfolio. This discipline requires some selling on the way up and best of all requires some buying on the way down. Hey, now here is a novel idea: buy low, sell high!"

That's a pretty harsh assessment of most investors, but, I fear, an accurate one. The evidence is overwhelming that investors, as a whole, have tremendous herding tendencies. They tend to buy at peaks and sell at troughs. Want proof? As I noted in my earlier Bore report entitled The Perils of Investor Overconfidence, investors tend to trade in and out of mutual funds at the worst possible times, chasing performance. Consider that from 1984 through 1995, the average stock mutual fund posted a yearly return of 12.3% (versus 15.4% for the S&P 500), yet the average investor in a stock mutual fund earned 6.3%. That means that over those 12 years, the average mutual fund investor would have ended up with nearly twice as much money by simply buying and holding the average mutual fund, and nearly three times as much by buying an S&P 500 Index fund. Factoring in taxes would make the differences even more dramatic. Ouch!

Over the next few weeks, I will address the following topics:
  • - Are historical lessons from past bull markets valid today?
  • - How can one be fully invested yet take advantage of market declines?
  • - Alternatives to full investment for those who do not have sufficiently long investment horizons.
  • - The perils of market timing.
  • - Why I am willing to time stocks, but not markets.

-- Whitney Tilson

Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. Mr. Tilson appreciates your feedback at To read his previous guest columns in the Boring Port and other writings, click here.