The best way to save for college
BY TERRY SAVAGE SUN-TIMES COLUMNIST Jul 14, 2006
Updated: May 3, 2013 12:14PM
Originally published: August 7, 2001
No matter what the ultimate resolution of this week’s wild swings on Wall Street, the ups and downs provide some potent lessons for today’s investors.
If a resolution to the upside convinces people that the stock market is a one-way street, then the market is setting us up for an even more convincing reality check. If, on the other hand, newer investors gain a healthy respect for the ability of the market to both create--and destroy--wealth, then the stock market will be on firmer ground. So here’s a look at some Old Lessons for the New Market.
No. 1: Don’t fight the Fed.
This is the classic first rule for market participants, and one that has been resoundingly ignored by proponents of the “new economy” viewpoint.
Technology does have to play by the rules of the Fed--or at least technology customers do. And the venture capitalists do, too. When money is flowing freely, it’s easier to throw it at a good idea. But when the Fed clearly, and patiently, aligns itself in the direction of higher interest rates and tighter credit, then the economy and the stock market eventually will feel the impact.
No. 2: The stock market is not a zero-sum game.
There has been a growing sense that the stock market is like a big tub filled with water that goes sloshing around from one side to another. Sometimes the water--read: money--flows into the tech stocks, and sometimes it flows into the old economy stocks, and sometimes into the financial sector stocks.
But there is not a fixed amount of money in the stock market tub. Wealth is created, and it disappears--just like water sloshing over the sides of the tub.
So the $500 billion in Nasdaq wealth that was lost in one day this week was not necessarily offset by the $213 billion increase in value in Big Board stocks. As the market declined, real--or imagined--wealth simply disappeared from individual 401(k) accounts, as well as from Bill Gates’ pockets.
Yes, for every share of stock purchased, there was a seller. But if it took less money to buy 100 shares of Microsoft on Tuesday than it did the previous Friday, then the person who sold at a loss was out the money. And when a stock price declines dramatically, even those who didn’t sell must face the fact that their wealth is less.
No. 3: Fear and greed are the greatest dangers to investment wealth.
History shows without question that the stock market is a wonderful way to accumulate wealth over the long run. In fact, according to Roger Ibbotson’s studies, there has never been a 20-year period, going back to 1926, when you would have lost money in a broad-based portfolio of stocks, such as the S&P 500.
Then why isn’t everyone wealthy? Why wasn’t it obvious until now that you can “get rich” in the stock market?
The answer is those two emotions that tend to rule most investment decisions: fear and greed. Without a disciplined approach to regular purchases (dollar-cost-averaging) and a buy-and-hold, diversified strategy, most people will be ruled by emotion.
Greed will encourage them to buy at market peaks, and fear will keep them from investing at market bottoms when gloom is thick. They’ll never have the emotional stamina to hold on for the long run.
Today’s investors figure they have that scenario under control: They buy on dips. But only a longer cycle will tell whether these dips are temporary, and whether they’ll continue to be followed immediately by new highs. The long run can be a very long time if you’re holding stocks at a loss. And a financially stressful time if you’re getting margin calls.
No. 4: Sell down to the sleeping point.
This was one of the first lessons I learned about the stock market. If it’s keeping you awake at night, sell down to the point where you can relax and stick with your plan. Being over-invested in a volatile market causes decisions to be made based on short-term considerations, rather than long-term plans. It’s easier to stick to your investment plans when your lifestyle is not on the line. Sticking to a regular investment plan is the way real stock market wealth is created--over the long run.
And that’s the Savage truth.
Terry Savage is a registered investment adviser for stocks and commodities and is on the board of directors of McDonald’s Corp. and Pennzoil-Quaker State Co. Send questions via e-mail at savage @suntimes.com. Her third book, The Savage Truth on Money, recently was published by John Wiley & Sons Inc.