Last year, we had the folks from a very successful organization come into Ottawa to facilitate a one-day workshop called “Creating a personal/business vision of greatness.”
This particular company set up a training arm to help other businesses and people learn from their many successes.
The founders of this unique group attributed the lion’s share of their success to one deceptively simple thing: their unwavering focus on the importance of building a vision today, which can help them create the future they want to achieve tomorrow.
Having problems isn’t always a bad thing
Each of the workshop participants came away with something different. What I found most insightful was the idea that it’s impossible to live a life that’s completely problem-free. Instead, what we should be focused on – as both business owners and investors – is how we can make our problems better.
In a business context, “better problems” means challenges like having too much business rather than too little, too many options instead of too few, or having to decide how best to invest your profits instead of wondering how you’re going to make ends meet.
For investors, one of the best “better problems” we should all be striving for is the question of what to do when the market declines. Why are market declines a better problem? Because if you’re going through a decline, it means you’re invested in the market. And if we look back at the last 100 or so years, being invested in the market has almost always been a very good thing.
The true test of investment success
Why is staying invested so important? Because over the long run, it doesn’t really matter what your rate of return is in any particular year, or how many units of currency you happen to have in your bank account at a given moment. For the vast majority of investors, the long-term value of their money is determined solely by how well it maintains (or increases) its purchasing power over time.
Just consider: a hundred years ago, having a million dollars would have made you one of the wealthiest people on the planet. Today, it can barely buy a two-bedroom condo in downtown Toronto. The reason for this shift comes down to one very powerful (and unfortunately unavoidable) force: inflation.
Given the reality of inflation, the only true test of an investment’s long-term success is how much it earns over and above the rate of inflation. Historically speaking, people who were invested in the stock market earned an average of twice as high a rate of return as bondholders after accounting for inflation.
That’s why being in the market – even a bear market – generally gives us much “better” problems over the long run than being out of it.
The premium power of equities
Of course, it would be even better if we had a crystal ball that let us predict all the market peaks and valleys, so we could move our money in and out at just the right time. But since there is no surefire way to consistently forecast what’s going to happen with the economy tomorrow let alone a year from now, the only real way to be sure of capturing the long-term premium return of equities is to stay invested all the time. And that means experiencing an occasional market decline.
Don’t get me wrong. Even if they are temporary, these “better problems” can still be tough to endure.
The average annual peak-to-trough market decline over the past century, for example, was around 15 per cent a year. Average declines of nearly twice that much have taken place about once every five years or so. And since the end of the Second World War, there have been three years where the markets dropped by close to 50 per cent.
But in spite of all that, the cash dividend of the S&P 500 since 1926 has still grown at a compound rate of almost 5 per cent. That’s more than one-and-a-half times the average inflation rate of 3 per cent. Since 1980, dividends have grown even faster, to almost 6 per cent a year. That’s double the rate of inflation over the very same period of time.
The best defence against our own bad instincts
With today’s 30-year projected retirements, that premium rate of return that comes from investing in equities will be even more crucial to protect the future purchasing power of your hard-earned life savings for as long as you need it.
But while we encourage all our clients to experience the “better problems” of being an equity investor, we also know that it’s still very difficult to be successful without help.
Current events combined with human emotions can lead even the smartest investor to make the same mistakes over and over again, whether it’s panicking your way out of a temporarily declining market or piling into the latest fad. In my experience, the best defense against these mistakes is to have a clear investment plan, and an investment policy that you frequently review and update.
So by all means, invest in a way that gives you the best problems you can find. Just make sure you have a great plan in place first, so you can be certain that all those “better problems” will also yield the best possible results.
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This article is supplied by Alan MacDonald, an investment advisor with RBC Dominion Securities Inc. Member–Canadian Investor Protection Fund.
This article is for information purposes only. It is not intended to be financial advice, and the opinions expressed are the opinions of the author only. Past performance is not a guarantee of future results. All assumptions, opinions and estimates made by the author are subject to change without notice.
Before acting on any recommendations, consider whether they are suitable for your individual circumstances, and seek out professional advice.
