by Archie M. Richards, Jr., CFP^®
January 22, 2001

My friend Peter recently commented, "There's so much talk about a recession these days. Won't the talk itself bring on a recession?"

No, Peter, it won't. There could be a recession if the Federal Reserve doesn't expand the money supply and cut interest rates in a hurry. But talk itself makes no difference. In fact, the more people who expect a recession, including investors, economists, market professionals, and television commentators, the less likely it will occur. Sorry, that's how the market works, call it counterintuitive, topsy-turvy, or just plain nuts.

Here's how the market does not work. Investors, collectively, do not turn pessimistic - because of talk about a recession, for example - and sell as a result. Some do, of course, but these are offset by others who buy under the same circumstances. Instead, prices fall, and this causes investors to turn pessimistic. When prices are at their lowest, pessimism is greatest.

The same applies on the upside. Prices do not rise because people turn optimistic. Instead, prices rise, and this causes investors to become more optimistic. Prices and sentiment work in parallel. Optimism is greatest when prices are highest.

If sentiment doesn't cause prices to change, what does?

You hadda ask. No one knows, exactly.

But this I do know: In the short term, at least, the stock market has to make the majority of investors wrong most of the time. Otherwise, everyone would put everything they have into the market and come out multi-zillionaires. Can't have that; there isn't enough real wealth to go around.

If there is a recession, no one should wait to buy stocks until the end of it has been officially announced. They'll be way too late. Sometimes, the prices start rising even before the beginning of a recession is announced. Did someone say topsy-turvy?

writes, "I am a 74-year-old widow, working part time and drawing Social Security. All of my savings are in stocks, money market funds and small CDs. In today's market and at my age, is there any point in transferring my holdings to index funds, especially Vanguard? Or am I just another shoulda when I coulda?"

Now is the right time, Jean. For can-do people like you, now is always the right time to buy index funds.

If you own stocks with substantial capital gains and you're not feeling tip top, perhaps you should leave well enough alone. Selling would incur big capital gains taxes, whereas holding until death would wipe out the capital gains altogether. While the value of the stocks would be included in your estate for estate tax purposes, income taxes on the gains would not be paid by anyone.

But you write as if you're hale and hearty. You're counting on at least ten or twenty more years, right? Your stocks haven't been huge winners, right? Go ahead with the index funds. Invest 50 percent in one that tracks the Wilshire 5000 or the Russell 3000, with the other 50 percent one-third each in index funds for Europe , the Pacific, and Emerging Markets. All this will expose you to about 4,500 companies in many countries. Diversification reduces the ups and downs. This not only cuts down on queasy stomachs, it increases safety.

With no stock research required, the costs of index funds are low. The Vanguard Total Stock Market Index Fund, for example, buys and holds the stocks selected for the Wilshire 5000 by Wilshire Associates. The annual operating costs are 0.20 percent, which is piddling. For the stocks abroad, Vanguard buys and holds the stocks selected by Morgan Stanley for its indexes of foreign stocks. The operating costs for these average only about 0.45 percent - still very low.

The U.S. market might fall after you make the shift. Oh sure, the index fund of U.S. stocks would go down with it. But the stocks you hold now would likely fall as well. Don't wait. The sooner you broaden your diversification, the better.

Put as much of your cash into stocks as you can, especially now, when stock prices are down and investors are pessimistic. If you need income from your mutual funds, by all means take it. Six percent seems like a nice round number to me. Take out more if you have to. Let me know how you're doing when you turn 94. By that time, I expect the Dow to exceed 100,000.