Stay the Course
When I wrote in mid-July 2007, the Dow Jones Industrial Average had reached 14,000. In mid-August, it had dropped to under 12,700. On January 21st, when I wrote again, the index had sunk to 12,099. Last week, the Dow closed at 12,266.
Well, these are interesting times. Many people are fearful. When fear is in the air, we can be anchored by the truth of what we have learned from history. The saying applies, “Those who do not know the mistakes of history are doomed to repeat the mistakes of history.” Here are some things we know.
We know that owning shares of companies (stocks) has helped investors significantly out-pace inflation over long periods. Stocks have averaged annual returns of over 10% historically (Morningstar Stocks, Bonds, Bills and Inflation).
Loanership (bond and CD investing) does not deliver the returns of ownership over the long run. The downside to stock returns is they are not consistent in the short run. Returns are variable. They are volatile. One year in a 100% stock portfolio may be down 10%. The next year may be up 20%. But over longer periods, the returns tend to hover more tightly around their historical, positive, double-digit averages.
So, the goal is to lower volatility as much as possible without sacrificing too much return. This is the art and science of portfolio management. We should be asking “How can I get the most return for the least amount of volatility?”
- We know that investing in a diversified mix of US and foreign companies lowers volatility.
- We know that avoiding concentrated positions in individual stocks by choosing baskets of stocks from different industries eliminates unsystematic risk–specifically company risk (the risk that a particular company’s decline could wreck your portfolio).
- We also know that high dividend paying stocks lower volatility.
- We also know that bonds and cash equivalents lower volatility, but also lower returns. So we add these to stocks based on a person’s age and risk tolerance to reduce volatility.
- We know that to eliminate all volatility is to predestinate ourselves to pitiful returns and a lower standard of living in the future. In other words, we know that some volatility is the price we must pay for higher returns and a better lifestyle during retirement.
The paradox principle of scripture applies to investing as well as life: We must die in order to live. We must sacrifice now in order to be rewarded later. In investing, we must be willing to sacrifice short term price stability and predictability for a more prosperous future. For those who understand this and are patient, they are rewarded. For those who are impatient and make decisions based on fear, they will lose their reward.
You must not judge your wisdom by short term results. The tortoise will always beat the hare over the long haul. This is a race that must be run with patience. The next short term move is unknowable, but the market has always trended up over the long run. People go to work, solve problems, and companies make profits. And this has happened throughout all sorts of financial crises and wars, including two world wars over the last century.
Remember, the media loves to report negative news rather than positive. As they say, “If it bleeds, it leads”. Good news is boring. Bad news sells. So if you watch the news and read the headlines, as most of us do, be careful to think independently and get more unbiased news with it. And when you see your portfolio going down instead of up, remember that this is natural, normal, and expected. When stocks go on sale, that is not the time to sell. It’s time to buy. If you needed the money now, you wouldn’t have invested in stocks to begin with. Your goal for your retirement nest-egg is to provide income over a 20 year or more period. If your retirement money is predominantly in cash and bonds, that is a long time to let the silent killer, some call invisible “black ice”–inflation–eat away at your purchasing power. And making good market timing decisions consistently has proven to be impossible.
If you have a well engineered financial plan, you must not faint and jettison the plan when times get tough. If you do, you may not accomplish your long term goals. It is during these times, that we prove if we are deserving of the long-term benefits of ownership investing. Those who run and hide in cash during market downturns do not deserve the higher returns rewarded to the real owners of companies who stay the course.
Also remember that the stock market is a leading indicator of the economy. It anticipates problems ahead. Often times, by the time we realize we are in a recession, the market is posting positive returns in anticipation of future economic growth.
The market today has, I think, to a large degree, anticipated a recession, and when fear and pessimism are prevalent, risk has been accounted for and prices are discounted accordingly. I’m not saying the market has bottomed out. Nobody can predict that. But as you will read in Dr. James Paulsen’s March 2008 commentary, https://www.wellscap.com/docs/ecomonic_and_market_perspective/EMP_0308.pdf , prices look quite attractive now. Assuming you have a well designed portfolio, instead of selling stocks now, you need to hold them. If you have cash on the side, earmarked for five years or longer, now is a great time to get it invested. Five, ten, fifteen years from now, you will be glad you stayed the course.