Earlier this week, I posted an article on the necessity of saying “no” to certain things that are detrimental to your goals. Joe, over at Personal Finance by the Book, has a similar article discussing how saying “no” will impact your life and your finances.

With the up and down ride the stock market has been experiencing a lot of people jump off the ride at the wrong time. More importantly, a lot of people get on the ride at the wrong time. Sound Mind Investing has an interesting post on short term vs. long term approach of investing.

If you are investing for retirement then you need to understand the market goes up and down all the time. However, over the long-term, the market has trended up. The thing to remember is not to make investment decisions based on emotion.

Riding a roller coaster can invoke some really strong emotions…but if you remain calm, it will always (or almost always) smooth out and the end result is good. When the market gets a little crazy, just stay calm and say “no” to the emotional pull to get out of the market. Investing is a long-term proposition that will pay benefits over time. That doesn’t mean you should stick with a stock or fund until it completely crashes. When things start getting a little ‘too exciting’ for you, check with your broker and get some advice; that is what you are paying him/her for.

Earlier this week I mentioned the stock market being up 2000 points and how we were committed to our current investment plan. Yesterday, we received our May statement for our Roth IRA and received a very nice surprise.

I have posted before how we have consistently contributed to our Roth IRAs and my 401k even while the market was tanking. While others were getting out in an attempt to protect themselves, we decided to ‘ride it out’ and keep plugging away. We have been contributing faithfully to our retirement funds and our kids college funds. No, I don’t like losing money, but while the market losses continued to add up, we were buying more and more shares of our mutual funds, with the same amount of money, because of the falling prices.

Now that the market has turned around, all of those ‘cheap’ shares are beginning to increase in value. How much? Well, for the month of May, our Roth IRA gained over 10%. Not bad for a single month.

Rally or Trap?

Every investor currently in the market has been pleasantly surprised with the 1500 point increase (as of this post) we have enjoyed over the last seven weeks. Many are beginning to whisper ever so quietly around the water cooler about the end of the Bear Market. Is is possible that the worst is behind us? Maybe, but before we get too excited, we need to understand that short term rallies can and do occur during a Bear Market.

In this month’s Sound Mind Investing (SMI) newsletter, Mark Biller, has a great article reviewing the first quarter results, titled Bear-Market Bottom or Just a Bounce?

In three furious weeks, it had rallied more than 23%, the sharpest rally of its kind since 1938. Investor psychology pivoted sharply, from overwhelmingly discouraged to cautiously optimistic. Few were willing to actually call it a bear-market bottom, but most everyone was secretly wondering if it just might be.

Biller reminds us that during the Great Depression, there were six rallies of more than 20% before the market really hit bottom.

At the Bottom?

Whether we are at the bottom, or just observing a Bear Market rally, one thing is sure. You should not try to time the market bottom. If this is the bottom that’s great, but your investment strategy doesn’t need to change.

If you have been consistently contributing to your retirement account, this rally is what we have been waiting for. As the market was tanking you were buying more and more shares at lower and lower prices. Now because of this little rally, you are reaping the benefits of remaining faithful. This type of increase is the true benefit of dollar cost averaging.

What if we are not at the bottom? What if the market goes even lower than it was just two months ago? Unless you are only days away from retirement, I would encourage you to just stay calm. Keep working your plan and don’t get crazy. If things start going down again, you will be buying stock while it is on sale. The key is to just stay calm and keep looking for the light at the end of the tunnel. The American economy has seen bad times before and we always work our way out.

One last thought. I you enjoyed reading the SMI article by Mark Biller, I would encourage you to sign up for their monthly newsletter. The information and service they provide is excellent. They offer a free 30-day trial subscription so you have nothing to lose.

One of my most memorable moments with my wife was a date to an amusement park before we got married. We were standing in line to ride a roller coaster and as we made our way to the front of the line, the young man in charge stopped us and informed us we would have to wait for the next car. Standing there at the front of the line, I informed my wife that I really hated roller coasters. It’s just who I am. I like to be in control, and riding a roller coaster is more out of control than I like. Fast forward 20 years and today we are riding one heck of a roller coaster with the most erratic economy in many years. I can honestly say that I still don’t like them, but I am learning to deal with the ups and downs.

Last week I was talking to my financial adviser and I asked him how the economy was impacting his business. He surprised me by saying that 2008 was a better year than 2007, and the beginning of 2009 is better than the beginning of 2008. How is this possible? I would think that financial advisers would be having a real problem, but he has found a way to turn a whole bushel of lemons into some pretty sweet lemonade.

Which brings me to the point of this post. Is this the time to get out of the stock market just in case we haven’t seen the bottom? I tell everyone the same thing. First, I am not a professional financial adviser. Second, unless you are ready to retire, ride this thing out. Right now there are a lot of people that are really afraid. They are afraid of losing their job and they are afraid of losing their home. They have lost a lot of money and they are afraid that they will lose even more before things turn around.

If I could offer you an opportunity to sit down with Warren Buffet, would you heed his counsel? Well, I don’t know Mr. Buffet personally, but I can offer some of his advice.

We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.

Right now, Mr. Buffet is taking advantage of this roller coaster and is putting a lot of money into the stock market. Why? Because a lot of people are afraid and he knows that by buying low, he is going to make a ton of money when (not if) the market turns around.

Let me remind you that we don’t think you should be investing in the stock market until you are out of debt, and even then don’t use money that you can’t leave invested for at least 5 years.

Average doesn’t mean Normal

We have all read or heard someone say that the stock market averages 11% a year. Unfortunately, not everyone understands what that means. According to merriam-webster.com, the word average is defined as:

a single value (as a mean, mode, or median) that summarizes or represents the general significance of a set of unequal values

Hopefully that definition with help everyone understand what an average is…no? Don’t worry, I am not sure I understand that definition and I have a BA in Mathematics. In layman’s terms, an average is the number you get when you take away from the big numbers and give to the small numbers (sounds a lot like our tax code) so that the numbers are equal. The one thing I can tell you is that average doesn’t mean normal.

What is Normal?

I found an article at Sound Mind Investing that gives a great picture of where the 11% average comes from. When you look at the chart below you will see the stock market returns since 1926. The first thing you notice is that there really haven’t been that many years where the stock market returned 11%. As a matter of fact there have been more years where the market lost 20% or more than years where the market earned 11%. When you look at the life of the stock market, you will see that last years dismal -35% loss really isn’t that abnormal. Normal for the stock market is almost anything, and that is exactly what we are seeing right now. Today the stock market was up over 230 points. Normal? I don’t think so, but I will take it.

What can we learn from this chart? It tells us that the stock market is not a place for short term investments. There will be years where the market doesn’t return 11% and that is ok. There will be years when the market returns a lot more than 11% and that is great, but you can’t quit after just one bad year. Be diligent with your investments, diversify and don’t panic. The foundation of our economy is based on the American people, and that is something in which I have a lot of faith.

chart credit: Sound Mind Investing

I think everyone will agree that 2008 was not a good year for the stock market, retirement accounts (including 401k’s and IRA’s) or just about anything else where savings or investing was concerned. The Dow Jones lost more than 33% over the last 12 months and that number has been the focus of a lot of news articles including blog posts. Although I agree that having the market go up makes me feel a lot better than watching it fall almost uncontrollably, there is something that we can focus on that will make us feel better about the state of the stock market.

We Will Survive

This first thing we need to remember is the United States is a very resourceful country. We have weathered bad times in the past and we have always prevailed. This time is no different. Given time, this Bear Market will end and we will again see the return of the Bulls. Until then what should you do?

The most important thing to do is stay calm. Pulling your money out of the market now would not be a good idea. Why? Simple. The market has already lost 33% in twelve months. If you had known the market was going to give up a third of its value before it happened and you got out you would have been a genius. However, now that the market is where it is, let’s find the silver lining.

The Silver Lining

Because the market is down, you can buy shares in just about any company or mutual fund at a really good deal. If you have been systematically adding money to your retirement account each month, you may think that you have lost a lot of money, but that is not exactly true. Right now, as long as your money stays invested in your mutual fund you have what is known as unrealized losses. That means on paper, you have lost money, but until you pull your money out you won’t realize the loss. Here is where things turn positive. If you have been faithfully putting money into your 401(k) or IRA each month you have been buying shares at cheaper and cheaper prices. Right now you have more shares in your account, than if the market had gone up. Why does that matter? Because as soon as the market turns around (and it will) you now have more shares that will be increasing in value.

Let’s suppose you started your retirement account last year by adding $10 a month every month. At the end of the year, you would have contributed $120 to your retirement account ($10 x 12 months). Let’s further suppose that in January, your $10 bought 1 unit of some mutual fund. So, in January, your account was worth $10. Now let’s release the Bear market. For our example, we are going to have the market lose $0.50 each month. At the end of the year, our (hypothetical) mutual fund was selling at $4.50 per unit instead of $10 per unit. A loss of 55%! Because the units in our mutual fund are only worth $4.50, the value of our account is only $79.19. Wait! That isn’t a 55% loss? What is going on? Because the price of the units each month were less than $10, each month we bought more than 1 unit. At the end of the year, we own 17.6 units of our mutual fund.

Going Up

If we now reverse the trend and this year we see the Bull market return, what happens when the value of our mutual fund start to increase? As you can see from the chart below, if our mutual fund only increases by $0.25 each month, by the end of the year, we will not only have made back all the money we lost in the first year, but our retirement account will be worth more than we have invested. How is that possible? Some call it dollar cost averaging others call it regular contributions, I call it “winning”. You now have 37.6 units of our mutual fund and you have something that you can be excited about. If the market is going down, you can buy more units with the same about of money. As the market goes back up you regain your losses at a faster pace, because you have more units going up in value.