sometimes hands-off is the best approach.
by anthony glomski
your $5 million high-net-worth practice
staying invested consistently is the all-weather approach. what do we mean by this?
more: what clients need to know | preserving wealth is a different mindset | three approaches to investment consulting | cashing out: your business clients’ five big issues
exclusively for pro members. log in here or 2022世界杯足球排名 today.
some of our clients reside near us in los angeles, where the average annual temperature is a very comfortable 65 degrees. in southern california, our “seasons” don’t vary much from the average annual temperature of 65. other clients reside in new york city, where the average temperature is cooler, but still a very comfortable 56 degrees. however, the temperature swings are much more significant in the big apple, ranging from stifling heat and humidity in the summer to icy temperatures and falling snow in winter.
in my home state of indiana, a similar average of 54 degrees is skewed by even colder winters. we also have clients in central texas. on the surface, the average annual temperature of 66 degrees is about the same as it is in california. but in texas, there are fiery, sticky summers and freezing, rainy winters, which means central texans have far fewer days at their comfortable 66-degree average than do southern californians.
the markets are a lot like the weather in texas or new york city. the long-term results are just fine, but rarely do we have a year in which returns are in the narrow and comfortable 10- to 12-percent band. true, stocks have delivered average annualized returns of around 10 to 12 percent since 1926 – making them the best-performing asset class by far – but those “average” returns rarely occur during shorter periods of time such as one year, five years or even 10 years. instead, investment returns are “lumpy.” we have above-average (hot) periods during which returns are much higher, followed by below-average (cold) periods in with returns are much lower. this is how we arrive at the historical average in practice.
to maximize your client’s chance of realizing the returns that stocks potentially offer over time, they must invest – and stay invested – for long periods of time. otherwise, they risk being out of the market during those robust periods when returns are well above average. as dimensional fund advisors founder david booth is fond of saying, “you’ve already paid for the risk, so it might be good to stick around for the expected return.”
further complicating matters is the impossibility of predicting consistently when market surges and swoons will occur. it turns out that stock market gains are highly concentrated – a relatively small number of days are responsible for the bulk of the stock market’s impressive long-term returns. miss just a few of those key days, and the investor’s long-term returns plummet. not convinced?
let’s say your client invested $1,000 in january 2004 in a fund that earned the same return as the s&p 500. by 2019, that $1,000 would have grown to more than $3,642 provided you left your money in that fund for the duration (see the table below). but if you had tried to time the market and were not invested during the best 20 days of each year during that period, your $1,000 would have grown to just $1,191 – less than one-third of what you would have earned had you remained fully invested.
| growth of $1,000 invested january 2004 through december 2019 | |
| s&p 500 | $3,642 |
| s&p 500 without the best 20 days of each year | $1,191 |
source: the s&p data are provided by standard & poor’s index services group.
so why is it so difficult for many to stay invested and to capture the full returns that the market offers? the fact is, humans tend to make investment decisions based on their emotions. we can blame this behavior on generations of successful marketing by financial services providers combined with human wiring.
the results, however, are decidedly bad. consider these returns* for the 20-year period through 2019:
- stocks (s&p 500): 6.1 percent
- bonds (barclays us aggregate): 5.0 percent
- portfolio consisting of 60 percent stocks/40 percent bonds: 5.6 percent
- average investor return: 1.9 percent
the typical investor earned far less than the underlying investments he or she owned during that 20-year period, because of actions such as poor investment selection and failed attempts to jump in and out of the financial markets at “just the right times.” as warren buffett said, “risk comes from not knowing what you’re doing.”
* returns are for the period ending december 31, 2019. average equity investor, average bond investor and average asset allocation investor performance results are calculated using data supplied by the investment company institute. investor returns are represented by the change in total mutual fund assets after excluding sales, redemptions and exchanges. this method of calculation captures realized and unrealized capital gains, dividends, interest, trading costs, sales charges, fees, expenses and any other costs. after calculating investor returns in dollar terms, two percentages are calculated for the period examined: total investor return rate and annualized investor return rate. total return rate is determined by calculating the investor return dollars as a percentage of the net of the sales, redemptions and exchanges for each period.