07/23/2008 05:12 am ET Updated May 25, 2011

Smart Advice for the HuffPost Investor: Is This the Time to Dump Stocks and Sit On The Sidelines (Part 2)?

I received a spirited reaction to last week's column in which I advised investors to stay the course. Here is an example:

Mr. Solin, while your advice is "tried and true" one could also assert it is tired and trite. These are times much unlike any we have ever seen.

Is this reader right? The markets continue to fall. The economic news seems to be endlessly negative. Is there any light at the end of this dark tunnel? Are we really confronting times "much unlike any we have ever seen"?

I have one guiding principle when it comes to evaluating investment advice. I ask myself whether those giving the advice have an economic interest in their opinions.

The media loves bad news. It sells newspapers and increases ratings. A recent study by the Business and Media Institute noted that current financial coverage is more negative than coverage of the 1929 stock market crash. The study found that "[D]uring the week of the 1929 stock market crash, daily news stories reported positive news more often than negative by a 4-to-1 ratio. The week that the Bear Stearns fall occurred, coverage was the complete opposite. Negative stories on ABC, CBS and NBC outnumbered positive 6-to-1."

The securities industry is the real beneficiary of bad news. By some estimates it generates over $645 million a day from commissions and bid ask spreads. Activity is its closest ally. Investors who buy and hold are its financial enemy.

Financial pundits thrive in volatile markets. Their "expertise" is in great demand. After all, how will investors know what to do without guidance from these experts?

Let's take a look at their track record.

An article in the New York Times published October 17, 1974, at the end of a two year market decline, reported that the majority of Americans shared the views of prominent economists that we were headed for a major depression.

In the ensuing 5 years, a globally diversified portfolio of passively managed funds allocated only 60% to stocks and 40% to bonds had annualized returns of almost 19%.

In August, 1973, when the Dow was at 875, the cover story of Business Week proclaimed the "death" of equities. Investors in the same 60/40 portfolio realized annualized returns of 9.42% over the ensuing 5 year period.

In September, 1990, 58% of 50 prominent economists predicted an imminent recession. A 60/40 portfolio achieved annualized returns of 13.01% over the next 5 years.

Is this history applicable? Naysayers keep repeating the mantra that the current economic conditions are unique. Are they right?

The stock market crashed seven times in the 19th century. The panic was not limited to United States. Markets in Germany and France suffered similar fates.

The 20th century ushered in far more volatile markets. In addition to the Great Depression of 1929, the markets imploded at least 7 times. The markets in Japan tanked in 1990, markets in the United Kingdom crashed in 1992, the entire Asian markets collapsed in 1997, the Russian markets dropped dramatically in 1998 and the burgeoning markets in China had a major correction in 2007.

The markets have absorbed the Pearl Harbor attack, the Cuban missile crises, the assassination of John F. Kennedy, the invasion of Kuwait, and the September 11 attacks on the World Trade Center.

The lesson learned from this history could not be clearer: Investors who did not panic prospered.

I fully understand the anxiety and even panic of investors in these turbulent times. However, there are lessons to be learned from behavioral finance, which examines why investors behave the way they do.

These studies show that investors are more likely to regret taking affirmative action than not taking any action at all. This makes perfect sense. Acting rashly out of fear or panic is far more likely to cause harm than letting those feelings pass and reflecting carefully on an appropriate course of conduct.

Dumping stocks in bad times is probably the worst investment decision you can make. Eugene F. Fama and Kenneth R. French have had a greater influence on portfolio management than anyone. Their seminal paper, "The Cross-Section of Expected Stock Returns" (Journal of Finance, June 1992), changed the way we think about the real source of stock market returns.

Another study by Fama and French found that expected returns on bonds and stocks are higher when economic conditions are weak and lower when conditions are strong.

We have extensive data indicating that the markets reward those who determine the right asset allocation for their investment objectives and tolerance for risk, and who invest in a globally diversified portfolio of low cost index funds. These investors buy and hold. They do not try to time the markets. They understand that sitting on the sidelines for even a relatively small period of time can cost them a significant portion of their market returns.

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.