The Past Three Months Can Teach Investors a Lot

I'm not bringing this to your attention to gloat over my advice back then to buy or my own purchases at what now seem to be bargain prices (see column of Aug. 21). I didn't know where the market was headed then and can take no credit for the subsequent rise. Rather, the recent market records and the intervening two-and-a-half months provide a good opportunity to assess what we've learned. Too often investors are so preoccupied with the future — what's going to happen next — that they miss some obvious lessons from the recent past. To quote philosopher George Santayana, "those who cannot remember the past are condemned to repeat it." Here are some of my conclusions:

There's something to be said for the old-fashioned buy and hold approach. While adroit traders had plenty of profit opportunities amidst the wrenching volatility, there were plenty of pitfalls, too — witness the closing of several prominent hedge funds amidst massive losses. You could have slept through the entire credit crisis, done nothing, and still come out ahead, without paying any trading commissions.

Never sell into panic. I find you can't repeat this too often. On Aug. 16, when markets hit their low for this period, trading volume was massive, and the panic selling was palpable. For every buyer there was a seller. No one has stepped forward to admit selling at the bottom, but there must have been millions of people doing it. Some may have been forced to do so by margin calls. But everyone else should look at themselves in the mirror and vow never to do it again. Panic selling should only be assessed as an opportunity to buy — never to sell.

Leverage is dangerous. Many readers have asked me why, if stocks have always risen over the long term, I don't use leverage to boost returns. The answer is the short term, as we saw this summer. Another group of geniuses got wiped out. I don't pretend to be a genius, and I want to sleep peacefully at night. I never want to be forced to sell by margin calls. The higher returns just aren't worth the higher risk. The S&P 500 index is up 11% this year. Even if your results are only average, what's so bad about that?

Central bankers won't let a desire to punish imprudent speculators get in the way of their central mission to protect the smooth functioning of the world's financial markets. Much has been made of the existence of a "Bernanke put," the notion that the Federal Reserve will bail out speculators by cutting interest rates. But to me this misses the point. For one thing, many speculators weren't saved by the Fed's cut. But more fundamentally, the Fed's job is neither to punish nor reward individual investors. As best I can tell, Bernanke was appropriately indifferent to the effect of rate cuts on certain prominent Wall Street managers. His job is to protect the rest of us by focusing on price stability, economic growth, and the functioning of capital markets. Whether the Fed was wise to cut rates by a half point remains to be seen. But we have every reason to believe that the Fed's motive in doing so was consistent with that mission.

There will always be volatility in markets, and accompanying buying and selling opportunities. If you missed this short-lived correction, and are chastising yourself for failing to take advantage of it, rest assured: You will get another chance eventually. There will be another correction, with accompanying panic and dire forecasts. Earlier this summer, volatility was so low that people were wondering if global liquidity really had smoothed out the usual bumps of investing. Now we know: It hasn't. Risk remains a fact of life. Embrace it and be prepared next time.