Investing: Contrarians rarely succeed
Given the new highs in the Dow Jones industrial average, you're going to be getting plenty of investment advice, especially from people who fancy themselves contrarians. Here's your first bit of advice: Successful contrarians are extremely rare, and most people don't really understand what it means to be a contrarian.
Here's your second bit of advice: Don't get wacky just because the stock market is surging. Look at how much you have in stocks, bonds and cash, and figure out if you have more than you want, given the amount of time you have and your risk tolerance. Then decide whether or not to trim back on stocks.
If you spend any time on social media, you'll always see some guy — and it's nearly always a guy — shouting that he's seen something that's a contrarian indicator for the stock market, and that the smart money is bailing out because of it. The indicator could be a newspaper headline, a brokerage ad, or even a casual conversation. ("The guy who sits next to me at work set up a brokerage account. It must be time to sell, heh, heh.")
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This kind of thinking is inspired by a possibly apocryphal tale about Joe Kennedy, father of the late president and well-known rich guy. Supposedly, Kennedy sold all his stocks when he got a stock tip from a shoeshine boy. If shoeshine boys were buying stocks, Kennedy reasoned, then there wasn't anyone left to buy stocks, and it was therefore time to sell.
Whether or not the story is true, basing your portfolio moves on indicators like this is silly, and for several reasons. First, it's based on the snobbish assumption that the whole world is wrong and you're right. Even for brilliant people, this is an unusual event. In fact, the whole world is right most of the time, at least when it comes to the stock market. It's only at peak inflection points that it pays to go in the opposite direction. Had you bet against the stock market the past 12 months, for example, you'd be in a world of hurt.
Furthermore, the public certainly isn't jumping up and down about the stock market the way they were in Joe Kennedy's day — or in the 1990s, for that matter. "I don't think the public is in the markets yet," says Donald Hodges, manager of Hodges Pure Contrarian fund, up 17.3% this year, vs. 13.8% for the Standard & Poor's 500-stock index with dividends reinvested. "The public hasn't warmed up to the market yet. These gains are being generated more by the professionals."
Finally, successful contrarians typically don't dump stocks wholesale. They buy stocks that they feel are not only unloved but unjustly so. "Contrarian investing is choosing a portfolio and going with it, not trying to time the market," says David Dreman, arguably one of the most well-known contrarians out there. It may start with a gut feeling — for instance, that airline stocks are undervalued — but a successful investor follows up by researching the stock and the sector.
Hodges does feel that airline stocks are oversold, and he may be one of the few people on the planet who does. "Nobody likes them," he says. But he likes Boeing, and added to his holdings of the stock when news about battery problems on the Dreamliner, its newest jet, became public.
Most of those unloved stocks don't make good cocktail chatter. "People want to be in something that's exciting," Dreman says. "Contrarian stocks are boring." What they have going for them, however, are low prices, relative to earnings, and a tendency for happy earnings surprises.
So what should you do, now that the Dow has hit a record high? A few things:
• Stay calm. That guy pointing to a magazine cover with a bull on it isn't going to make you any money.
• Look at your portfolio. What percentage of your assets are in stocks, bonds and money funds? Is this intentional?
• If it's not, make it so. A reasonably conservative portfolio is 60% stocks and 40% bonds. Most times — but not always — the two go in opposite directions. If you have a long time before you'll spend your money, you can afford to be a bit more aggressive and increase your stock holdings. If you're nearing retirement, however, you'll need to scale back a bit.
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If the run-up in stocks has put you significantly past your target allocations, then it's time to rebalance. You shouldn't have to do this often — just when your target is 10 percentage points or so past its target.
Consider a $10,000 investment made 20 years ago — 60% in a large-company stock fund and 40% in a government securities fund. By now, you'd have $35,930 in your account, and $25,442 of that would be in your stock fund. So your portfolio would be about 71% in stocks. That's 11 percentage points more than what you had wanted, so you could sell some stocks and move the money to bonds to bring your allocation back to 60% stocks and 40% bonds. (Or, alternatively, to money funds.)
The key here is that you made a conscious decision about how much you wanted in stock and bonds, and adjusted your portfolio accordingly. You didn't jump in or out of stocks because the S&P 500 made a record high, or because your Uncle Ralph bought Apple, or because some guy was raving about the correlation between Major League ticket prices and new lows in the Dow Jones industrial average.