As stocks reach new highs, it is important for us to keep some perspective and continue to take a logical approach with our finances.

 

The U.S. stock market amassed a total return of 193% between 1991 and 1999. During the exuberance of the longest bull market in U.S. history, individual investors feasted on huge helpings of stock market growth. Investment losses seemed to be a thing of the distant past. Many investors did not realize, or they simply didn’t care, how much risk they were taking in the 1990’s. Then, just a few months into 2000, the bubble burst! Many investors felt helpless as their portfolios hemorrhaged losses for three years. When the carnage finally ended, the stock market had lost 43% of its value. Investors had not seen such losses in over twenty-five years. 

 

More recently, consider the stock market collapse of 2008.  Old wounds were re-opened and new ones were inflicted on several generations of American investors. For many, the 37% market decline in 2008 didn’t just drain them financially, but depleted them emotionally as well.

 

So, why the history lesson you may ask? I have three key points for you:

 

1. Another market drop will come. The only question is “when?”
2. You can’t let emotions drive your decision-making when it does.
3. A sound plan can help you keep your sanity during tough times.

 

Here’s another real life story to help make my point. “Mr. Jones” took all of his IRA money and bought 1,000 shares of a publicly-traded technology company for $80 per share in 1999. His total purchase price was $80,000. Mr. Jones hoped the stock market’s strong performance would continue in the 2000s and that his “all in gamble” with the one stock would be his golden ticket to a carefree retirement.

 

Incredibly, by the end of 1999, the stock rocketed from his purchase price of $80 a share to $641. By February 24th of 2000, the stock’s after-burners had kicked in, and it reached a staggering $1,230 per share. Mr. Jones’ gamble had paid off beyond his wildest expectations. An early retirement was within sight. In less than a year, his $80,000 investment had grown to $1,230,000! 

 

To tell you his story, I must have met Mr. Jones at some point. When do you think that happened? Was it when his IRA was worth $641,000? How about when it hit $1,230,000? Was that when he came in for advice? Nope. Why not? Because at the time, many people, including Mr. Jones, thought the stock market would continue to soar into the stratosphere! Next stop . . . the moon! No, make that Mars!

 

Mr. Jones came to see me in May of 2000, when his stock was plummeting back to Earth. His IRA was now “only” worth $512,000. After hearing his story, I expected him to ask me how he could diversify, protect what he had left or create an income stream. No, Mr. Jones just wanted to know, “When’s the stock going to go back up?” It is funny now, but it was awfully sad at the time. You can guess what I told him, “I have no idea what the stock will do. If you want to retire in a year, you’d better sell the stock now and diversify. Take some money off the table and put it into safer investments that provide reliable income. And, let’s build a written financial plan so you can retire with confidence.”

 

Unfortunately, Mr. Jones could only see a $700,000 loss of value from February 24th to May 5th. It didn’t matter to him that he had, in fact, made $430,000 in just one year on his original $80,000 investment. Mr. Jones left my office on May 5th, 2000 frustrated by my advice to sell the stock. That peak value of $1,230,000 had wrecked his perspective. I encouraged Mr. Jones to come back when he was ready to do some realistic planning. After another $80,000 in losses, Mr. Jones surrendered to the wisdom of getting out of just one stock and getting into a financial plan. On May 18th, 2000, Mr. Jones sold the stock for $438,000. The stock’s value continued to implode. By December 31st, 2009, it had fallen from its all-time-high of $1,230 a share down to a measly $2 a share.

 

I have a special message for those who subscribe to the investment philosophy, “I won’t sell at a loss no matter what.” My response is simple, “Where would Mr. Jones be today if he had refused to ever sell at a loss?” I can tell you precisely where he’d be: he’d have one stock worth a couple thousand dollars and a lousy retirement. A wounded pride and $438,000 in cash are far better than $2,130 shrouded in a fortress of self-delusion. 

 

I call this emotional decision-making the “Casino Effect,” because it is awfully hard to get up from the blackjack or roulette table when you are down. You feel like you have to at least “break-even” before you can stop. Then, when you start winning, you can’t stop because “you’re on a roll!” These same feelings can show up when the stock market is hitting “all-time-highs.” Please don’t let your emotions get in the way of sound planning for you, your family and your financial future.

 

 

David D. Holland, a CERTIFIED FINANCIAL PLANNER™ practitioner, hosts a weekday radio show at 9AM on AM1380 Ormond Beach, AM1230 New Smyrna Beach and AM1490 Deland. He has also authored two books in his Confessions of a Financial Planner series. Holland offers investment advice through Holland Advisory Services, Inc., a registered investment adviser in Ormond Beach. He can be contacted at (386) 671-7526. Email your financial questions to info@DavidHolland.com.