As financial advisors, one of the most vital aspects of our job is to stand between our clients and bad investment decisions. This becomes especially important during market downturns, when investors are most likely to react emotionally to the market. During unstable market conditions, it is our job to be the voice of reason.
The goal of this article is to display the overwhelming academic findings that support a buy and hold investment strategy, in the hopes that it may prevent you from making poor financial decisions during turbulent times. If you find yourself unsure of what your next steps should be, you can always contact a TrueNorth Wealth financial advisor to aid with your social security, insurance, and all other long- and short-term investments.
1. You Can’t Afford to Be Out of the Market
Imagine you have just checked your most recent investment statement, and notice that your investments have dropped by 25%, a Great Depression era stock market plunge. Immediately you feel the panic sinking in.
What should I do?! Is this plunge going to continue? Should I sell now and wait on the sidelines?!
I want you to stop right there and read the following findings from a J.P. Morgan Retirement Study.
Using a 20-year time period from Jan. 1, 1999 to Dec. 31, 2018, if you missed the ten best days in the stock market, your overall return was cut in half.
Over 20 years – if you missed the 10 best days in the stock market – your overall return was cut in half.
So, imagine that you want to pull your money out and wait for tough times to pass – there are just ten days, over a 20-year period, that are critical to the success of your investments. How do you know if you’re going to miss one of those ten, or even half of those ten days? There is no way to know with certainty when these top ten days will be, which is why you cannot afford to be out of the market.
To highlight the point even further, over that same 20-year time period, if you were to miss the top 20 days, your return goes from a positive to a negative annual return!
This truly highlights the opportunity cost of sitting on the sidelines, unsure of when to get back in the market. No one can say with specificity which 10 or 20 days, out of the 7,300 days in a 20-year time period, will be the best, and it is expensive to miss the mark on this one. This is an important factor to consider when you find yourself reacting to the short-term swings of the market.
The bottom line is that none of us know which way the market will go in the short run, and by attempting to jump in and out at different times, we could potentially miss the small window of opportunity that drives the majority of investor returns.
As Warren Buffet says:
“It’s not about timing the market, but about time in the market.“
2. The Average Investor vs. The Average Investment
In order to discuss this point, you need to first understand the difference between an investor, and an investment. This may seem simple to some, but it is important to clarify. An investor is the individual purchasing stocks and bonds, in the hopes of growing or protecting their dollars. An investment is what you purchase, this is the actual stocks and bonds. So, when comparing the average investor’s returns and the average investment returns, we are comparing the difference in return that the individual received, vs. what the actual stocks and bonds produced. This difference has been labeled the Behavior Gap.
This might seem a little confusing… I mean, shouldn’t the investor realize the full return of the investments that they own? The data tells a different story.
So just how large is this behavior gap, you might wonder? Well, let’s look at the data compiled by our custodian, SEI Private Trust Company:
As you can see, the average stock market investor is losing 3.46% per year to their behavioral missteps. What we see happening is investors becoming buyers of stocks when the market goes up, and sellers of stocks when the market is going down – which results in a losing strategy of “buy high, sell low.” We all understand that we should be trying to buy low and sell high, but our emotions have a way of convincing us otherwise. Again, this is a major piece of what we do as your financial advisor; we help you avoid that gap so you can realize the entire investment return.
It’s human nature to avoid painful experiences and gravitate towards rewarding ones. This is a survival mechanism rooted so deeply in our brains that it tends to manifest itself throughout our daily lives. This helps to explain why we so badly want to sell when stocks are going down, and buy more when they are going up, which is the exact opposite of what we should be doing from a price perspective. By allowing emotions to get in the way, investors negatively impact their ability to meet their desired financial goals. Even a minor negative difference in returns, spread out over a 30-year time period can completely derail any financial plan.
That minor difference can be the deciding factor between the ability to retire now, or the need to work an additional 1, 5, or even 10 years.
Benjamin Graham, the author of the well-known book The Intelligent Investor, put it best:
“The investor’s chief problem—and his worst enemy—is likely to be himself. In the end, how your investments behave is much less important than how you behave.”
3. Bear Market = Stocks on Sale
Imagine you decide you’re going to buy a car. You might begin by defining what it is you want the car to do for you. For some, it might need to be the ultimate weekend warrior, able to pull a fifth-wheeler trailer with ease, and room in the bed for endless adventure gear. For others, it might need to be a practical, fuel-efficient commuter with a hybrid engine. Whatever it may be, once you narrow it down to what you are looking for, the real search begins. You might contact a handful of dealers, offering them the opportunity to compete for your business in this upcoming purchase. At the end of the day, once you decide the specific car you’re looking for, it is then simply a matter of finding the best price.
This is the mentality that we use when purchasing most things in our life, with one exception: stocks. Stocks have an interesting way of really messing with our psyche, and invoking intense emotions. When stocks go up, we tend to get over-excited and greedy, thinking that we are missing out on some amazing opportunity, which leads the average investor to buy, buy, buy. Conversely, when we see the stock market take a dive, we get fearful and anxious, assuming the worst, assuming the market will never come back, causing the average investor to sell, sell, sell.
This is the opposite of what we should be doing. We should be recognizing that when stock prices go down, the only thing we should be doing is buying more at a lower price point, and when stock prices go up, it should be a lot less exciting because we are now buying stocks at a new, higher price point.
The Oracle of Omaha, Warren Buffet once said:
“We should be fearful when others are greedy, and greedy when others are fearful.”
By sticking to this new mentality, we can avoid getting caught up in the emotional whirlwind experienced by the average investor, and make prudent decisions regarding our investments.
This goes hand-in-hand with our automated rebalancing strategy. Rebalancing is simply the buying and selling of stocks or bonds within your investment portfolio to maintain a desired asset allocation (your mixture of stocks and bonds). We automatically rebalance every quarter, which is great value added to our clients, because not only does it help to maintain the proper amount of risk associated with your investments, by adjusting for fluctuations in the ratio of stocks/bonds, but it is also an automatic tool used to buy low, and sell high.
The way this works is quite simple.
For easy math, let’s say that your account has a value of $100,000 and is in a 60/40 (stock/bond) portfolio. This means that 60%, or $60,000 will be invested in stocks, and 40%, or $40,000 will be invested in bonds. Then imagine that we see a 15% decline in your stock holdings, but because stocks and bonds are uncorrelated (they don’t move together), your bonds remain the same. Now you are left with $51,000 in stocks ($60,000 – 15%) and $40,000 in bonds. This means that with your new account value of $91,000, you are currently weighted at 56% stock and 44% bonds (not our original goal). At quarter-end, this would trigger a rebalance, which would then sell off 4% of your bond holdings and buy an additional 4% stock holdings at the new, low price point. In addition, if the reverse of this scenario were to happen, and the stock market went up by 15% instead, we would then be selling the over-weighted stocks (selling at a new, high price point), and purchasing bonds to get back to our original asset allocation.
By automating the rebalancing process, we are simply automating good investor behavior, that allows you to maintain the desired exposure to the market, while continuously buying low and selling high.
4. Volatility = How Often You Check the Market
Imagine you have two clients, Jack and Jill. Both clients begin investing at point A. They both have the same annual contributions, the same portfolio of investments, and the same time horizon. Jack loves to check the market daily, while Jill prefers to review her investments once a year. Both clients will inevitably end up at the same destination, point B, but who do you think experiences more volatility? While Jack is checking the market every day, he gets to feel the high highs, and the low lows of each market swing. Because of his constant exposure to the market, Jack is far more likely to make emotional reactions to the short-term movements in the market, as opposed to Jill, who simply goes on living her life, ultimately arriving in the exact same endpoint, with only a fraction of the difficult emotional experience.
By understanding that investing is a long-term process, we can reduce the amount of volatility we experience by setting up healthy parameters for checking on the status of the stock market. That is not to say that we should never look at our investments, but simply that we should establish healthy guidelines and standards for how often we will expose ourselves to the emotional rollercoaster that is the short-term market.
5. Markets Have Rewarded Long-Term Investors
It is important to understand what the money is being used for when saving and investing. If the funds are earmarked for long-term uses such as living expenses during retirement, then we need to treat them like long-term investments. This means keeping a long-term mindset and ignoring the daily swings of the stock market. The data is clear, over long time periods, the market trends upwards. This accounts for all those scary situations, whether it be a trade deal with China, the rise or fall of oil prices, or which way interest rates are going, all these things are already built into the upward trend of the market over long time periods.
It is an amazing feeling once you realize that your financial success is not determined by the short-term fluctuations of the market. There is a sense of peace knowing that even if we see another Great Recession, or even a market drop like the Great Depression, that these things have already been accounted for in your financial projections.
As you can see from the chart below, if you were to zoom in at any one point in time, you could have serious upward or downward movement in your portfolio. However, over time, the market relentlessly marches upward and onward. It outpaces inflation with ease, and rewards those who are in it for the long haul.
Over a period of roughly 90 years, $1 invested in the S & P 500 (US Large Cap Index) has grown to an astonishing $7,347, outpacing inflation by 524 times!
This chart drives home the value of maintaining a long-term perspective on your investments.
To bring it all together, this is what I would like to leave you with:
Our job is to be the thing between you and scary markets
Getting out of the market to stand on the sidelines is far too costly
Emotional investors lose an average of 3.46% of their return every year
When the stock market is down, things are on sale – and we have automated the process of taking advantage of this
Volatility is simply a matter of how often you look at the market
Long-term investors have been rewarded
Thanks for reading and please feel free to share this with anyone whom you believe might find it a beneficial read. Always remember: it is our job to stand between you and poor financial decisions. Don’t hesitate to reach out to your investment, retirement, or sale of business advisor when you are starting to feel stress and anxiety build up, as we are here to be your voice of reason every step of the way.