If you play the oddsThe question started coming in last summer: “Is it time to sell?”

Many are still asking.

But the right answer, then and now, was the same: “No, it’s time to grit your teeth and hold.”

Why?

Easy. It’s a lot easier to blow a market call than to do it right. We don’t know the future. When we think we know the future, we routinely make our biggest mistakes. One telling bit of evidence is the return investors get on their money versus the returns realized by basic buy and hold indexes. In an article for the Journal of Pension Benefits, N. Scott Pritchard says that 401(k) plans are a miserable failure because most of us make bad choices.

His evidence is the returns investors earned from 1988 through 2007. During that period the S&P 500 returned 11.81 percent annually and Treasury bills returned 4.53 percent--- but the average investor achieved a return of only 4.48 percent.

This was done by methodically buying equities when they were up and selling when they were down. Our excesses as both buyers and sellers destroy the returns we could achieve simply by buying, holding and toughing it out.  

Another reason this is the time to hold (and perhaps buy) rather than sell is that after a year (or decade) like the last one, the odds favor higher than average future returns, not lower than average future returns. Last week I cited research by Steven Leuthold in which he examines future equity returns from different valuation levels. That research shows that stocks are now on the cheap side (but not dirt cheap). In previous comparable periods stocks returned an average of 14 percent a year over the next five years.

It should be noted that this would NOT be a bonanza. If your equity portfolio lost half its market value over the last year--- as many did--- then you’ll need five years of 14 percent returns just to get back to where you were in 2007. That said, it would be a shame to miss the uptick.

Still worse, it would be a shame to jump from stocks into bonds just in time to get whacked in that arena, too. According to Leuthold research, if you bought a “safe” 20-year Treasury at recent yields and then interest rates rose to more a more typical 5.5 percent rate, your return over the next five years would be an annualized loss of 1.6 percent. That, in turn, is why most of us should pick an asset allocation--- the relative proportion of stocks and bonds in our nest egg--- and stick with it. Timing bets rarely work. Being virtually inert does work, even after trauma years like 2008.

At this point, some readers may be wondering if I drink lithium enriched water. In fact, we’re only talking about historical averages and I’m not alone. It seems there is even more lithium in the water in Toronto or Waco. That’s where Dale L. Domian and William Reichenstein, respectively, live. Writing for the January issue of the AAII Journal, the two finance professors tells us that last year may have been miserable but several technical measures, including current price to earnings ratios, indicate that stocks are now cheap. They specifically suggest that this is NOT the time to bail out. They also suggest that this is a good time to restore your asset allocation to its original target and, just maybe, increase it a bit. Remember, if your portfolio was 60/40 (equities/fixed income) a year ago, it’s probably 50/50 today.

So where, you might ask, is the cash that will fuel a rising market? Isn’t everyone broke, tapped out, or otherwise encumbered?

Not hardly. In spite of nearly invisible yields, the level of cash being held in money market mutual funds has soared in the last year. According to Money Fund Intelligence, a money market fund newsletter published by Crane Data LLC, equity mutual fund assets fell below $4 trillion at the end of November from $6.5 trillion at the beginning of 2008. Over the same period, money market fund assets soared from $3.1 trillion to more than $4 trillion. As a consequence, money market funds now account for the highest percentage of mutual fund assets since 1990.

Of course, it could be different this time. But just as we weren’t entering a bright “new era” in 1999, we probably aren’t entering a dark “new era” in 2009.

On the web:

July 23, 2002: Reichenstein vs. Huggard on variable annuities