Buy Fear and Sell Euphoria

I can't quite remember this quote originated, but I quite like the idea of "buying fear and selling euphoria."  It goes along with Warren Buffet's quote: "You should try to be fearful when others are greedy and greedy when others are fearful."  It essentially means when other investors worry and sell their assets in a panic, the people who buy and hold tend to do very well.  When everything is going great and people are putting all their money into the markets, those who get out tend to take advantage of the higher prices and do very well again.  This past year, the markets have been very fearful with all the volatility but those who were greedy and bought when everyone else was selling would be sitting on some gains right now.

Back on August 8th, the market had tanked to a year-to-date low of around 1120.  The U.S. credit rating was cut and the market had fallen about 17% from the most recent high.  I made my post then commenting on how attractive equities looked.  People always see their portfolios go down and they are afraid of more losses, so they sell now.  It is the emotion of fear that works its way into their decisions about their investments.  I mentioned that it was a good time to put some money into the market since everything was cheap.  Since then, the markets have moved up and down with the S&P flying back and forth between 1120 and 1220.  Most recently, as you can probably look up, the S&P has worked its way back up to 1290.  If you had just bought the S&P ETF, you could have been sitting on a 5 month gain of 15%. 

Is now the time to sell?  We might still be heading down later on so it might be good to take some money off the table.  The past month has seen an amazing rally and people might be willing to buy "euphoria" at a premium.  Of course, you also have to take into account short-term capital gains tax but I think taking some money off the table wouldn't be a bad idea at this point in time.  For 2011, the S&P 500 was about break-even, meaning if you invested on January 3, 2011 and sold on December 30, 2011, you would have roughly a 0 net gain or loss.  People sometimes call 2000 to 2010 the lost decade because the S&P 500 was break-even over that time period as well.

Experts are expecting the same volatility as last year, meaning large price swings over short periods of time.  These swings could go up or down but the end result is more risk.  With savings accounts yielding 1% or often much less (like 0.05%), the 2% dividend yield on the S&P 500 looks very attractive.  By owning the market, you get paid a higher interest rate and can capture some upside as this economy slowly recovers.  Of course, you have to take into consideration the fears of Europe's economy collapsing, Chinese growth slowing down, and many other factors that may affect the future business environment.

As we go through 2012, if you are looking at stocks and thinking about putting some money in the market, don't be scared off by sudden drops.  Those are the times people are fearful and willing to sell at discounts to get rid of everything.  Let the drops happen and wait for the markets to cool a little before buying some of that fear.  In the short term, the markets may drop a little more or rise back up but after a few years, when everyone is celebrating the return of the good times, you'll be happy you bought when you did.

And if the world does end in 2012, any downside in any portfolio won't matter anyway.  However, I am willing to bet on an optimistic future and look toward stocks for some higher long-run returns.