One of the things I’ve been hearing a lot of lately is people saying: “wow, the stock market has had such a great run! I can’t wait until it cools off a bit, so I can invest some money.”
This kind of reasoning never ceases to amaze me – and not in the good way. There’s no question that the equity markets have been having a stellar six years, ever since the “great plunge” of 2008. A lot of that stellar performance has simply been a recovery from the bottoming-out that hit the markets back in ‘08.
The problem is, as human beings, our primitive brains have a tendency to ignore that kind of historical context for whatever’s happening around us, and allow our instinctive fear response to guide our actions instead. If last year was great, for example, then we say that the market must be peaking, so we’d better wait until it goes down again before investing any more money. And if the last year was tough, that must mean the market’s going to keep on plunging, so we’d better make sure our money doesn’t go anywhere near it!
See the pattern? Unfortunately, there’s really no way to avoid worrying about what’s going to happen to our hard-earned money. We wouldn’t be human if we didn’t have these fears. But what we can do is try to put our fears aside for a moment, and ask ourselves what the facts actually have to say about this “fearsome rally” we’ve been enjoying over the last six years?
The answer is: it depends on which statistics you prefer.
If we look at the last five years, as of July 2014, the S&P 500 had an average compound return of 16.7%. This puts us in the top 20% of all five-year periods since 1928. But if you look at the last 10 years, we’re in the bottom 30% of all 10-year periods over the same timeframe, with a compound return of just 8%. If you look at the last 15 years, we’re way down in the bottom 7% of all 15-year periods since 1928, with a compound return of only 4.5%.
Since I encourage investors to use the rest of their lives as a reasonable investment horizon, you would think there’d be a bit more optimism for the future out there, seeing as how we’ve just been through one of the worst 15-year periods in the history of the equity markets. But most of us simply aren’t wired for that kind of optimism. We’re wired for the fear that kept us alive on the savannah 50,000 years ago, when one wrong move meant you ended up as lunch for something sabre-toothed and hungry.
Don’t get me wrong – there are plenty of mistakes to be made in the investment world. You can put all your money on one stock and hope to hit the jackpot. But that’s gambling, not investing. You can follow the soothsayers who tell you that oil is going to $250 a barrel, or gold is on its way to $10,000 an ounce, or whatever other narrative with absolutely no historical precedent is currently being peddled on the TV news, and then invest your money accordingly. But more often than not, that’s just a great way to have a horrible investment experience.
Luckily, if we can get past the fear (and the fear-mongering), we don’t have to resort to any of these extremes. Instead, we can simply invest our money in a reliable, proven way, and get great returns in the process. Provided, of course, we’re willing to sit tight for a couple decades.
In my own practice, I advise my clients to invest the growth portion of their portfolios according to the Rule of Thirds: take a third of your money and buy a broad spectrum of U.S. small- and large-cap stocks. Invest another third in a broad spectrum of small- and large-cap non-North American stocks. Then take the last third of your money, and (you guessed it!) buy a bunch of Canadian small- and large-cap stocks. Re-balance back to a third of each once a year. Then rinse and repeat until you’re ready to retire.
An approach like this means you don’t get hurt when Greece gets clobbered, or U.S. financial institutions falter, or the loonie drops 20%. Because no matter what happens, most of your money is always going to be safely somewhere else, and your long-term timelines mean you can afford to wait out all those “doomsday scenarios” anyway.
Of course, there are no short-term guarantees. This is still the market, and markets are always going to be completely unpredictable. That’s the nature of risk. And when it comes to investing, short-term risk is the price you pay for higher long-term returns. Your job as an investor is to decide how you’ll manage the risks you need to take to get the growth you want to achieve. For my money, the best way to do that is to be as diversified as possible, and then simply stay put through all of the inevitable ups and downs.
So how would that broadly-diversified (and really boring) portfolio I mentioned have done over the last 20 years? Even with the huge drop in 2008 and the under-achieving results of the past 15 years, a Rule of Thirds approach would’ve given you a compound average return of just over 9% a year, if we use the various small- and large-cap indices as a reference*. If you prefer dollar numbers, this means that $100,000 of your hard-earned money invested 20 years ago would now be worth $600,000.
The next 20 years is unknown, and completely unknowable. We can’t predict what will happen tomorrow, let alone two decades from now. But what we can do is take the lessons of history and invest simply, in a way that will capture growth and, through diversification, avoid the lion’s share of all the disasters that will most certainly come our way between now and then. Or, we can take door number two, and invest all our money according to some unprecedented narrative that appeals to our emotional fears, rather than what our brains know to be true.
It’s your call. Your fear is telling you one thing. But the numbers suggest your best chance for a great retirement is to take a deep breath, have a good plan and a bit of discipline, invest simply – and go with history. Anything else is just trying to make something that’s really pretty simple, a whole lot harder than it needs to be.
*Source: Dimensional Fund Advisors, Model Portfolio (November, 2014)
Alan MacDonald an investment advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.
All material by Alan MacDonald, Investment Advisor at Richardson GMP Limited. The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP or its affiliates. Past performance is not indicative of future results.
Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.