Fraidy cat wants out of this stock market

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NEW YORK (Money) -- Question: Is it time to move our 401(k) out of stock funds and into bond funds? I did this back in 2000 and saved my 401(k) from huge losses.

I'm getting nervous about the current market and wondering whether it's time to make another switch. - Cathy Covemaker, Orion, Illinois

Answer: Did you ever play a tennis match where every backhand you hit kissed the line. Or a round of golf where all your approach shots not only hit the green but rolled to within a foot of the cup for a sure birdie?

Those types of perfect moments are seared indelibly into our brains. And we tend to think of those winning shots not as luck, but as evidence of just how good we are.

Somehow we manage to ignore the more frequent instances when that backhand flies into the net or our approach shot buries itself in a sand trap.

So what does this have to do with your 401(k)?

Well, you're suggesting that because you were able to move out of stocks and into bonds back in 2000, you'll also be able to jump out of the stock market and into bonds at the right time today.

I wouldn't be so sure. You see, our selective memories extends to our investing, and we don't even consider the possibility that perhaps luck played a bigger role than skill in some of our greatest moves.

Exiting stocks in 2000 was great. But was this the first time you made such a move or were tempted to? Is it possible you switched out of stocks at other times when the move didn't work out so well?

If you think back to the Nifty Nineties, you'll recall that many people were antsy about stock prices well before the bust began in early 2000. Former Fed chairman Alan Greenspan made his famous "Irrational Exuberance" speech back in December of 1996.

Given the lofty price-earnings ratios on stocks at that time and the rising level of anxiety following Greenspan's speech, it would hardly be a stretch for a wary investor like yourself to consider getting out of stocks.

Anyone who did flee stocks back then because they were "nervous about the current market" would have missed a four-year run from the beginning of 1996 through the end of 1999 during which stock prices gained 155 percent.

And let's think for a moment about your exit from the stock market in 2000. You say that you avoided huge losses. Terrific. But when did you get back into stocks?

Clearly, you switched back into equities at some point since you're thinking of getting out of them now. But when exactly did you get back into stocks? The answer to that question bears directly on just how successful your strategy was.

Ideally, you would have wanted to move back into stocks just as they hit a bottom in October 2002.

Had you done that and stayed in stocks until now, you would have gained about 85 percent (not counting dividends, which would boost your return even more).

But if you had waited until mid-2003 to re-enter the market - waiting until it felt safe - your gain would have been cut nearly in half to 46 percent.

And if you had held off until the beginning of 2004, you would be sitting on a return of just 26 percent.

My point is that in investing you can't just view one move in isolation. If you're considering getting out of stocks, you've also got to deal with the issue of when you would get back in.

Let me give you an example from my own experience.

After the stock market crash of 1987, I decided to buy a couple of shares of Berkshire Hathaway (Charts, Fortune 500), the company run by investing guru Warren Buffett, that were then selling for about $3,000 a share, down from about $6,000 before the crash. Within a few months, Berkshire shares rebounded to $4,000.

Now, having interviewed the great man himself, I knew that Buffett was a big proponent of buying and holding for the long term. Really long term. He once said his favorite holding period is "forever."

Although I too have always been a big believer in long-term investing, at the time a little voice in my head began to whisper that I should sell and get my 33 percent profit while the getting was good.

So I sold.

At first I felt like a genius - until Berkshire shares began climbing and climbing and climbing.

Today, with the class of Berkshire shares I unloaded for $4,000 selling for $134,000 a share, I realize that selling those Berkshire shares wasn't the brilliant move I thought it was.

Even today, when the mood about stock prices is so negative, it's hardly a given that the market is about to plummet. Indeed, stock prices are hardly overvalued.

Of course, jittery investors could still send stock prices south in a hurry, especially if we get more bad news about the subprime mess.

That's why calling turnarounds in the stock market is an iffy business at best. Ultimately, it's a guessing game that isn't worth the effort. I say you're much better off setting a mix of stocks and bonds that makes sense given your planned retirement date and then sticking to that mix regardless of what the stock market is doing at any given moment. (For more on how to fix that mix at different stages of retirement, click here).

Who knows, maybe you did call it exactly right in 2000. But just because you bucked the odds once, that's no reason to take a chance with your retirement stash again.