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.
More on Investing
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.
Rob Bennett often writes about how to achieve financial independence early in life. His bio is here.