Lessons from 2009: Unexpected Bursts and Staying Invested

(MoneyWatch)  As 2009 showed us, no one has a clear crystal ball that tells us when to be in and out of the market. That's why it's important to understand that jumping in and out of the market is more likely to do harm than good, especially when you consider that some of the markets' biggest gains have come when they were least expected.

The Largest Gains Often Come When Least Expected
While there were some pundits who may have called the timing of the bear market correctly, I'm not aware of anyone who predicted that a great bull market would begin on March 10. And that shouldn't surprise anyone. Markets have often provided their greatest returns when least expected. Consider that from July 1932 through June 1933 (right in the midst of the Great Depression), the S&P 500 Index (then the S&P 90) returned 163 percent. Here are some other examples:

Bad Market		Good Market
September 1929-June 1932	-83	July 1932-June 1933	+163
September 1933-March 1935	-18	April 1935-February 1937	+133
January 1957-February 1958	-8	March 1958-July 1959	+55
January 1973-September 1974	-42	October 1974-December 1976	+86
November 2007-February 2009	-51	March 20009-December 2009	+55

Thus, the S&P 500's rally of 64.8 percent from March 10 through year end was certainly not unprecedented. Unfortunately, far too many investors weren't there to earn those returns, as there was a net outflow of funds from the equity market in 2009.

Once You Sell, It's Hard to Get Back In
When the surf is rough, lifeguards place the red flag on the beach as a warning not to go in. When it quiets down, the green flag goes up, indicating it's safe to go back in the water. Unfortunately, the same isn't true with stocks -- there are no green flags to let you know when it's safe to buy again.

Consider the case of an investor who found out that he was overconfident of his ability to stand the stress of the kind of bear market we had in 2008. By November 20 of that year, he realized he had overestimated his willingness to take risk. He sold out of stocks with the S&P 500 closing at 752. His plan was to wait until the market had been up for more than 30 days (or when the green flag would be up).

With the S&P 500 closing at 903 at the end of the year (and having missed out on a rally of 20 percent), he buys again, believing that it was now safe to get back in. Unfortunately, the market dropped another 25 percent by March 9 and he had enough. Do you think this investor will ever be able to buy again? And of course, unless he had, he missed the greatest market rally in 70 years. One of the problems with market timing is you have to be right twice, not just once.

Follow the series: Lessons from 2009

Part one: Planning Tips and Investment Myths

Part two: Rebalancing and Investment Horizons

Part three: Unexpected Bursts and Staying Invested

Part four: Refreshers