Q: Like many, my 401k has turned into a 201k. I am much more receptive now to the things you’ve been writing about than I was six months ago. The problem is it seems stupid to sell my aggressive stock fund now and lock-in these losses.
A: In business school, they drilled into us the idea that we should ignore sunk costs. This is easier to accept analytically than it is psychologically. You naturally want to recoup at least part of your losses before you sell to diversify. The problem with this natural tendency is that it contains the implicit assumption that, starting today, your aggressive stock fund will do better than what you would buy if you had your asset allocation where you would like it to be.
In this month’s allocation, I have three times as much allocated to precious metals as I do to domestic stocks. This is because, given where we are today, I think precious metals will do better than stocks. You may agree with me, but you don’t want to sell your stocks now after they’ve dropped so much. If you wait, stocks may indeed have a bounce. Then you could sell and buy some gold. The problem is that, if we’ve been right, gold will have bounced even more than stocks and you’re still worse off than if you had just bought gold before either bounced.
If you wait, in essence you’re saying, “I think gold has better long-term prospects than stocks, but maybe in the short-term stocks will outperform gold.” This may happen, but it is not an investing strategy. It is simply a hope. You’re hoping that in the short-term prices move against your long-term view so that you can implement your asset allocation change when the relative returns are even more advantageous. This is simply trying to time the market based on hope. It may work this time, but unfortunately, that’s even more dangerous to your long-term financial health than if it doesn’t.
