market folly

Joel Greenblatt is quite a prevalent value investor. He founded hedge fund Gotham Capital, is an adjunct professor at Columbia University's Business School, has founded the Value Investors Club and more. Most recently, he has focused on Magic Formula Investing, a strategy that seeks to buy good companies with high earnings yield and a high return on invested capital.

Market Folly's quote of the week from Greenblatt centers on the topic of how to invest when you can't handle a 40% drop in the market:

"So, what should you do? The answer is annoyingly simple. I believe the stock market is a great place to make money over the long term. Despite the last decade's poor returns for the broad market averages (and including the knowledge that you are not forced to buy the average stock, but can follow a strategy like Formula Investing to buy a portfolio of above average companies at below average prices), I firmly believe almost everyone should have a significant portion of their assets in stocks. But here it comes - few people should put ALL their money in stocks. Whether you choose to place 90% of your assets or 40% of your assets in stocks should be based largely on how much pain you can take on the downside. As painful as it might be, if you put only 40% of your money in stocks and the market falls 40%, the simple math says you'll only be down 16% (though it depends on where the rest of your assets were at the time!)

However, and most importantly, once you've chosen an amount you can handle, every time the market drops, hopefully you will no longer be tempted to sell all your stocks, put on your feety pajamas and roll up into a little ball. Over the long term, despite significant drops from time to time, stocks (especially an intelligently selected stock portfolio) will be one of your best investment options. The trick is to GET to the long term. Think in terms of 5 years, 10 years and longer. Do your planning and asset allocation ahead of time. Choose a portion of your assets to invest in the stock market-and stick with it! Yes, the bad times will come, but over the truly long term, the good times will win out-and I hope the lessons from 2008 will help get you there to enjoy them."

~ Joel Greenblatt

For more market insight from this value investor, check out Greenblatt's book: You Can Be A Stock Market Genius (a book we might add that is recommended by none other than Seth Klarman).