Should I get back in the market now?

I got this question from a reader this morning. In a recent column I predicted a correction–a 10% decline–in stocks prices, and reader Mark B. asked if I meant a decline of that magnitude from January’s close or, if not, what? He added, “Many of us are late buying back in, and may be thinking about re-entering smarter.”

The correction I anticipate is from the recent bull market high, reached in the middle of January. As of Jan. 31, the S&P 500 was down 3.7% from there, so I mean a further decline of at least 6.3%. I am hardly alone in making this forecast.

But this adds emphasis to Mark’s original question: When should I buy back in? Here’s my answer.

First of all, I would suggest that if you’re asking the question, you’re approaching investing the wrong way. Implicit in the question is that you have sold out. That’s a market-timing decision, whose flip side is, When do I buy back in? But market timers know the answer to that question even before they sell. If you don’t know the answer, you’re not an experienced market timer, so why are you selling out?

Investing is not a form of savings. When you save, you can be 100% sure of what will happen to your money. Investing is different. The odds are out of your hands from moment to moment. Only over a long period does time itself bring the odds into a form that can be successfully estimated. So if you need money within a relatively short time period–say, three to five years–it should be held in the form of savings, such as bank accounts or Treasury bills.

It follows that an investor’s minimum time horizon is five years, and his maximum is something longer than this–say 20 years, at least. (If you’re 65, you’ve still got 20 years left, according to actuarial tables.)

It also follows that the recent performance of financial securities, while interesting to an investor, is not terribly significant, and is likely to be a contrary indicator. That is, stocks have been in a funk for more than a decade, and bonds have been fabulous, but I think you’d be a fool to invest heavily in bonds right now, since interest rates are bound to go up significantly over the next five years, and bond prices go the opposite way.

Stocks, meanwhile, are up more than 50% from their nadir last March, but unless Washington really mucks things up they’ve got much higher to go; at least another 30% over the next three years, if history is any guide.

So whether or not you (or I) expect a correction immediately ahead, stocks are a buy today and bonds are not. In actuality, even bonds are a buy–in moderation, to damp down volatility in the portfolio of someone of middle age, and in quantity if you need to rely on the income in old age. Relative to themselves, however, bonds are expensive and stocks are not. They’re not cheap, as they were a year ago, but they’re not dear.

So if you’re waiting for a signal to come back to stocks, you have it: In the average stock market bull cycle, stocks make half their gains in the first year and the other half in the next several. In the average bear cycle, they lose a quarter to a third of their value. (Last time they lost half, but that’s rare.) So net, net, you lose less than you gain if you simply stay the course, ignoring current conditions.

The model portfolios I run, of exchange-traded funds and a 401(k) portfolio of mutual funds, change very little for years at a time, and are tweaked only to try to wring a few extra dollars out of performance. The real money, which is also the easy money, is made by sitting pat with a well-diversified portfolio of stocks, bonds and alternatives like energy. All the time.