I have had conversations about investing strategy with tens of thousands of middle-class investors over the past ten years. I have learned that 90 percent of us do great damage to our portfolios by repeatedly falling victim to three deadly illusions.
Deadly Illusions #1: Standing Still Is Good Enough.
Stocks are selling today at roughly the same price that applied in January 2000. It’s not a Lost Decade for stock investors anymore. It’s a lost dozen years. Many Buy-and-Holders are not alarmed. They continue to rationalize the 12 years of poor returns, telling themselves that stocks will perform well again sometime in the future and they will make up for lost time.
Stocks will indeed perform well again in the future. Stocks will in future days perform very, very, very well. The entire historical record affirms this reality. But the investors who have been sticking with large stock allocations for the past 12 years will not be able to make up for lost time. No way, no how.
If you were age 35 in 2000 and had a portfolio value of $100,000 and are age 47 today with a portfolio value of $100,000 (adjusted for inflation), you are not holding steady. You are falling behind, so far behind that there is little hope that you will be able to catch up before you reach the age at which you hope to retire.
We all have 40 years to finance our retirements, presuming that we start investing at age 25 and plan to retire at age 65. Stand still for 12 years and you have lost nearly one-third of the time available to you to achieve your goals.
If you were 30 percent down according to the numbers, you would be panicking today. The reality is that you are 30 percent down. It’s just that you are looking at the wrong number. You are looking at your portfolio value when you should be looking at how many years you have remaining to close the gap between your portfolio value and the amount you need to have saved on your planned retirement date.
Retirement planning is a game governed by a time limit and those who have been standing still for 12 years are i reality falling desperately behind.
Deadly Illusion #2: The Power of Compounding Returns Only Need to Be Considered When You Are Moving Forward.
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the power of compounding on your side. If your portfolio value is not moving steadily upward over time, you are missing out not only on the gains you would like to see each year. You are also missing out on the compounding returns on those gains.
All of the calculators that tell you how much you need to save each year to be able to retire at age 65 assume gains on stocks of about 6.5 percent real each year and annual compounding on those gains. Those who think they are standing still by not losing large nominal amounts are fooling themselves and are in fact falling farther and farther behind with each passing month.
Deadly Illusion #3: You Can Never Know Where You Stand Without Taking Into Consideration the Valuations Level That Applies
Consider two investors. One turned 35 in 1982 and had accumulated $100,000 at that time. Another turned 35 in 2000 and had accumulated $200,000 at that time. Which investor did a better job of providing for his retirement during the first ten years of his investing lifetime?
The first investor did a far better job. Stocks were priced at one-half of fair value in 1982. That means that a 100 percent gain was baked in to any stocks purchased at that time. The nominal value of the portfolio of the fellow who had accumulated by $100,000 was $100,000 but the real, lasting value of that portfolio was $200,000.
The second investor was doing a far worse job. Stocks were priced at three times fair value in 2000. The real, lasting value of that fellow’s portfolio was something less than $70,000. That’s a portfolio size of roughly one-third the portfolio size of the first investor.
We all need to work harder at developing the insight needed to see through the deadly illusions that ruin our hopes for achieving financial freedom at a reasonable age.
I respectfully disagree. Buy and hold is denigrated by people who believe in an illusion, too. Buy and hold does not mean buy and forget, or buy and ignore. Most importantly buy and hold is not a one time thing as the investor continues adding money to their portfolio.
Your example of a 35 year old in 2000 with a portfolio of 100k leaves out the fact that over those 12 years they were adding money, buying low. The portfolio is now worth more than 100k. Also many of the stocks (better yet index funds) were purchased low and now have a large amount of potential which can significantly increase compounding in the future. Since this person won’t need the money (assuming long term intentions) for years to come, I think they did the right thing.
Starting in 2000 here are my increases (and decreases) in net worth year by year: -2.19%, 33.95%, 23.24%, 20.3%, 12.53%, 15.94%, 12.29%, -16.44%, 24.93%, 17.02%, and 3.92%. All with buy and hold.
I’m grateful to you for adding some balance to the discussion here, AJ. I can only write from my perspective and that is obviously limited by the life experiences I have behind me. To learn together, we need to hear both sides. So thanks for helping us all out with your comment.
Please take care.
Rob
Thanks Rob for the reply. Two heads are better than one. Whether someone plays devils advocate or whatever, it’s nice to get a different perspective. I think you are correct in assuming that a lot of people view buy and hold as the easy way out. They forget that they also have to be vigilant.
I’m with AJ on this as well. I have been investing for 30 years and the last 12 have been the most productive. When I finally realized that I could’nt predict the market, I started investing for dividends. Buy good companies and hold. I have more than doubled my portfolio in this time and dividends keep increasing. Yes, ocasionally you will have to weed a little as companies dont always stay profitable. But with diversification this keeps loses to a minimum.
Thanks much for stopping by and sharing your thoughts, Loma.
I wish you the best of luck with your strategies!
Rob
I like to think of myself as a long term investor, rather than a buy and hold one. I still have stocks bought back in the 1980’s. I have also bought and sold stocks over my investment life. I would sell a stock that is not performing as I would like and I do not see improvement in the future.
You may not be ahead in the US market over the past 12 years, but the market has not been flat. During that time you could have bought stocks that are worth more today than when bought.
We in Canada have done a bit better over the past 12 years, but because the market can go 10 or 12 years and not be any further ahead as far as capital gains go, is why I invest in dividend paying stocks for the long term. I have never been in the position where my dividend income did not go up some each year. I have also bought stocks in special situations because the stock was priced far too low and made capital gains.
If you invest there are always going to be good times and bad times. This does not mean that you cannot make any money over the long term.
Thanks for sharing your thoughts, SP.
It’s interesting that three people who generally are not in agreement with my views elected to comment on this post. I don’t see that often enough. There’s room for lots of different viewpoints on investing. We’re all in this together and we all learn more when we are exposed to a variety of viewpoints.
Robert Shiller is my main man. Jeremy Siegel is the main man (or at least one of them) for the Buy-and-Holders. I love the story that Shiller tells about how their families often vacation together. That’s the way it should be. People with all viewpoints need to say exactly what they believe while always showing respect and affection for those with different takes.
These comments make me happy!
Rob
That’s why I love this communications medium, Jukka. When people are learning something from posters on both sides of a question, we are all doing something right.
Rob
AJ really did a good explanation for it.But rob still have a point.It was really a good blog.I learned to both of you guy’s.