Riding Out A Volatile Stock Market
By Ralph Smith
Wednesday, April 16, 2008
As Thrift Savings Plan participants have watched their stock funds decline in value over the past few months, an inevitable question arises: "Is this a good time to buy more of the TSP stock funds?" Or, a different version of the question: "Is this the time to sell the TSP stock funds?"
My crystal ball has never been sufficiently accurate to predict the short-term direction of the stock market and each investor will have to make to make his own buy and sell decisions or decide to ride out the current stock market decline.
Here are several observations that may help—or at least highlight the dilemma an investor will face if you decide to buy and sell your TSP stock funds to coincide with the ups and downs of the stock market.
Whistling Past a Graveyard
A down market such as the one we have been experiencing often ends with a large sell off that occurs when investors are beginning to wonder if the market will ever go up again. In other words, when the pessimism becomes sufficiently widespread, many investors will simultaneously decide to sell their stocks and accept their losses. Once that occurs, the market often starts to head back up thereby ensuring that those that sold have just lost money.
A small column in the Wall Street Journal suggests that investors are still upbeat and that the moment of extreme pessimism has not yet arrived. It quotes a Merrill Lunch analyst that this indicator is "nowhere close to suggesting equity investors are exhibiting extreme pessimism." Or, to put it more bluntly, the stock market may have further to fall before it heads back up.
Bull Markets Return When Least Expected
Writing in Smart Money, columnist James B. Stewart says "For those of you wondering what a bear market feels like, now you know."
And, on a more optimistic note, he says "All bear markets end eventually. The average length of a bear market has been 18 ½ months, but more recent ones have been shorter." And, finally, "Bull markets usually begin when things look their worst." He also notes that "no one is arguing that U.S. stocks were or are in a bubble" and that stocks are now well below the average price/earnings ratio of our stock market.
In other words, stocks are relatively cheap now and the market could (but might not) start heading back up at any time.
Historical Perspective
When your retirement fund balance looks gloomy because of a fall in the stock market, here is some historical perspective that may give you a broader perspective.
The C fund is based on the S&P 500 index. It is a broad-based index of stocks. Here is a compilation of the worst days of the stock market since June 1983. The chart below, compiled by investment adviser Dan Weiner, shows how much the stock market went down in one day (reflecting the "extreme pessimism" referenced above) and how the same index had reacted one year later.
| Worst Days Since June '83 | 500 Index 1-Day Drop | 500 Index 1-Year Later |
| 10/19/87 | -20.5% | 27.0% |
| 10/26/87 | -8.3% | 28.1% |
| 10/27/97 | -6.9% | 24.2% |
| 8/31/98 | -6.8% | 40.3% |
| 1/8/88 | -6.7% | 19.2% |
| 10/13/89 | -6.0% | -7.1% |
| 4/14/00 | -5.8% | -11.7% |
| 10/16/87 | -5.2% | 0.7% |
| 9/17/01 | -4.9% | -13.0% |
| 9/11/86 | -4.8% | 38.6% |
| 4/14/88 | -4.4% | 18.1% |
| 3/12/01 | -4.3% | 0.2% |
| 11/30/87 | -4.2% | 20.6% |
| 9/3/02 | -4.1% | 18.4% |
| 10/22/87 | -3.9% | 17.7% |
So what does this mean for TSP investors?
Generally, an investor who purchased the S&P 500 index (through an index fund such as the TSP's C fund) after a big drop has fared well by the following year. The best day to have bought was when the stock market fell 6.8% in August of 1998 after President Clinton's revelations of a relationship with a White House intern and Russia's default on its debt. Twelve months later, investors had a return of 40.3%. There have been a few instances where the market continue to go down. For example, in September 2001, the market was down an additional 13% after having dropped almost 5% shortly after the terrorist attacks on New York City and the Pentagon although these instances are a small minority of the general trend. (You can check out the monthly and the daily TSP rates of return in the TSP Corner.)
One more item to put your TSP investments into perspective: TSP investors tend to follow the same instincts as the larger universe of stock market investors. The largest redemptions in the TSP stock funds occurred at the bottom of the bear market in 2002. TSP investors reflected the same "extreme pessimism" as many other investors and locked in their losses--just before the stock market started going up again and continued to go up for the next several years.
Use these examples as you see fit--and good luck with investing your future retirement funds!
© 2009 FedSmith Inc. All rights reserved. This article may not be reproduced without express written consent of FedSmith Inc.
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