The new year is here, and a pair of Bloomberg reporters recently marked the occasion by highlighting the overwhelming optimism prevailing in the stock market:
Two years of stocks going straight up have chased just about every skeptic from the U.S. market. Among professional forecasters on Wall Street, none tracked by Bloomberg sees a retreat in 2015, with the average estimate calling for an 8.1 percent advance [...] Pessimism, the constant companion of a bull market poised to become the second-longest since the Kennedy administration, is suddenly nowhere to be found after the Standard & Poor's 500 Index climbed 44 percent since 2012.
The article revealed that this was the first time since 2009 -- a year in which the S&P 500 climbed 23% -- when those surveyed unanimously agreed that stocks would rise in the new year.
As a result, some may think now is the perfect time to pour money into the stock market, while others may think it's time to take the money and run, recalling Warren Buffett's oft-repeated line, "Be fearful when others are greedy, and be greedy when others are fearful."
Yet a broader look at the context of Buffett's quote reveals that neither camp has it right.
Buffett: Ignore the noise
This Buffett quote originated in his 1986 letter to Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) shareholders, where he discussed how his company makes its investment decisions:
We have no idea -- and never have had -- whether the market is going to go up, down, or sideways in the near- or intermediate-term future. What we do know, however, is that occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics will be unpredictable. And the market aberrations produced by them will be equally unpredictable, both as to duration and degree. Therefore, we never try to anticipate the arrival or departure of either disease. Our goal is more modest: we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.
Does this mean that because euphoria reigns and investors are bullish, we should therefore be fearful? As Buffett would have it, not necessarily.
Buffett reiterated that same quote nearly 20 years later in his 2004 letter to shareholders, adding more context for individual investors. He named a few reasons why many investors' returns were "mediocre to disastrous," including the fact that people tend to make investment decisions "based on tips and fads rather than on thoughtful, quantified evaluation of businesses." He also called out investors' "start-and-stop approach to the market marked by untimely entries (after an advance has been long under way) and exits (after periods of stagnation or decline)."
He concluded by saying:
Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.
Buffett wants us to see that trying to time the market is incredibly dangerous, and if we buy stocks simply because we hear they will go up, and sell when they go down, the results will be "disastrous." And the data proves it.
Consider an article by Vanguard highlighting the need for discipline in investing. If an individual made a $10,000 investment at the beginning of 1988 and pulled out of the market when their balance had fallen by 25% and re-entered when the market had risen by 15%, they would have $54,000 after 24 years. Yet if they had done nothing and simply let the money grow along with the stock market, that same $10,000 initial investment would be worth more than 50% more, standing at $84,000.
Further, in a 2011 study that chronicled the behavior of more than 65,000 investors from 1991 to 1996, Dr. Brad Barber and Dr. Terrance Odean found that the 20% least active traders outperformed the 20% most active traders by a remarkable 7 percentage points a year.
The key takeaways
So what does all of this have to do with us as we consider what to do with our money in 2015?
The fact that many pundits think the stock market will rise in 2015 should have absolutely no influence on our investing decisions. And the same would be true if the pundits thought the market might fall.
This is because it has been proven time and time again that the best decision for many of us when it comes to saving for the future is putting aside a set amount each and every month into a low-cost index fund and letting the market take care of the rest. Buffett himself has even noted this is what he plans to do with the money he is leaving his wife.
For others who feel comfortable with their ability to make investment decisions on their own, what the market may do should have little to no influence on whether or not it is appropriate to invest in the stock of a specific business.
If hours and hours of research have shown that a business makes a sensible investment at its current price, and then that price falls after the investment has been made, then long-term investors should be glad, because this allows them to buy more at an even better price.
Put simply, whether you're investing in index funds or stocks, then the experts' thoughts on what the market may do should have little to no influence on your personal investing choices.