After we’ve just had a year where stock market returns surpassed most estimates, it’s worthwhile to remember why we have markets. Markets exist to set prices for things, from stocks to apples. Markets aren’t perfect, but they’re the best we have. Kind of like democracy. In the approximate words of Winston Churchill, democracy is the worst form of government, except for everything else that has been tried from time to time.
Some people don’t like the prices that markets produce, so they try price controls, or they try nationalization of assets. These invariably fail.
So the best thing to do is let markets set the price. This does not mean the price is always perfect. The old joke about a free-market economist is that he won’t pick up a $10 bill lying in the street because in theory it shouldn’t be there. The rest of us, who think markets have imperfections, will gladly pick up that $10 bill.
I give you this brief justification for markets because even though I think markets are mostly efficient, there are times where they overshoot or undershoot, when the $10 bill is not where it should be. I think this is one of those times. Specifically, it’s one of those times when the market is overshooting.
My advice is that you not consider all the wealth you can amass if the market surges higher, but rather consider whether you can stomach a 20% or 30% drop in the price of stocks, which might last a year or two; or whether you can handle several years of below average returns. If you can, fine. If not, it might be time to think again.