Recs
By Morgan Housel | More Articles April 27, 2012 | Comments (5)
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"In risk assets, you make 80 percent of your money 20 percent of the time."
The next time you think it's a good idea to get in and out of the market based on some vague notion that you can predict ups and downs, remember that line, which came from investing great Jeff Gundlach during a presentation last week.
Smart investing is not complicated, but it can be terribly difficult. The single biggest reason why most investors fail is simple and widespread: Money flows in and out of assets at exactly the wrong time -- in just when things are expensive, and out just as they're cheap. One 2007 study found that mutual fund investors earned an actual annual return of 1.6% below their funds' stated performance from 1991 to 2004 due to buying high and selling low. Compounded over the course of a lifetime, that can literally be the difference between retirement and no retirement.
It happens over and over again. And it will keep happening in the future. Unless you understand Gundlach's advice, you'll probably fall for it as well.
Stocks outperform most assets over the long run. Most agree on that, and history is pretty clear on setting the record. Ideally -- and rationally -- anyone with more than 10 years to invest would buy stocks at good prices and forget about it. You know you're in the right asset for the long haul. So why fret and bother second-guessing, tweaking your portfolio between other assets?
Part of the reason investors second-guess stocks is due to how returns have been marketed. Started by academics and run with by Wall Street marketing geniuses, the concept investors have been told time and time again is that stocks return something like 7% to 9% a year over the long run -- better than any other asset class. And that's true. They have.
But that can be misinterpreted to imply that stocks return 7% to 9% every year. And folks, they emphatically do not. While the long-term average annual return works out to 7% to 9% a year, what happens in between is wild and chaotic. In fact, stocks spend more years down more than 20% or up more than 20% than they do within the 7% to 9% range. Here's how it breaks down since 1928:
Sources: Yahoo! Finance, author's calculations.
Even this chart hides how skewed returns are over time. I've shown before that there have been about 21,000 trading sessions between 1928 and today. During that time, the Dow went from 240 to 13,000, or an average annual growth rate of 5% (this doesn't include dividends). If you missed just 20 of the best days during that period, annual returns fall to 2.6%. In other words, half of the compounded gains took place during 0.09% of days. That's a more detailed version of Gundlach's wisdom.
Now, every time that stat is used, someone says, "Sure, but what if you missed the worst 20 days?" Indeed, if you missed the 20 worst trading days since 1928, average annual returns jump to over 7% (before dividends).
But what's interesting about those 20 worst days? Most happened at nearly the same time as the best 20 days -- 1933, 1982, 2002, and 2008. It's implausible to think anyone could have avoided the worst days and hit the best days without simply being lucky. It can literally mean in Monday, out Tuesday, back in Wednesday.
Most of us at The Motley Fool think that the best way to build wealth is to buy good companies at good prices and hold them for a long time. Staying invested, in other words. That could mean having to endure a few years -- sometimes several years -- of really bad performance. That's OK. It happens. It's a perfectly normal of part of stocks' long-term superior performance, as counterintuitive as it seems. "Volatility scares enough people out of the market to generate superior returns for those who stay in," Wharton professor Jeremy Siegel said last year.
What we're not into is thinking we can time the market -- get in now, get out now, "I'm expecting a weak second quarter," that sort of stuff. The number of people who can do that consistently and profitably is a rounding error compared with the numbers who try it and end up burned. Most will end up missing out on the 20% of the time when 80% of the profits are made.
There is a place for bonds, cash, gold, and other assets, of course. If you're nearing retirement, or need to access your money at some point over the next decade, being 100% in stocks doesn't make sense. If you don't have an appetite for ups and downs (and many don't), don't even try stocks in the first place. And sometimes valuations make so little sense -- like 1999-2000 -- that selling stocks makes sense for long-term investors based on valuations (but not market timing).
But for most investors most of the time, the surest way to build wealth is to be invested, stay invested, and not get scared out because of temporary fears. Many will ignore or forget that advice. And most of them will end up poorer than if they had not. It's happened in the past, and it will happen in the future.
Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.
Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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See, the only problem with the whole assertion of staying invested through and through is that there are many people who danced right into the 2008 crisis and never quite recovered - Circuit City, Wachovia, Lehman, Bear Stearns (hat-tip to Kramer), CIT group, Borders, Countrywide - you know this list.
Between 2008 and 2009 over 8,000 companies (public and private) were placed in administration, liquidation or receivership. There is no such thing as a sacrosanct corporation.
Any investment - stock, bond, derivative, venture round, can fail. That is why we research and understand our investments and develop entry and exit criteria - when that criteria is met, we take action. We don't buy and hold right into bankruptcy.
To be honest, I would rather miss a few basis points on an uptick than lose a bunch on a market collapse. When the market disintegrates, it does so fast and ruthlessly. All exits become too small and retail investors are usually the ones that get trampled on the way out.
That said, I agree with the 80% of the returns 20% of the time. It can even be 95% of the returns 1% of the time if a black swan event occurs and like MIchael Burry or Kyle Bass or John Paulson, you are skeptical and continually educating yourself.
@sikilizabuy
I don't think Mr. Housel was suggesting to hold stocks no matter what. I think the article can be simply summed up with with three sentences:
- Stay invested long-tern companies in good companies.
- Stay away (in any time frame) from bad companies.
- If you invest in a good company that turns bad, valuations get to extremely-high levels or your thesis for initially buying the company chances, get rid of it.
Something like Circuit City was a bad company long before the crisis hit. Its bankruptcy in 2008 was inevitable (even if the great-recession didn't happen). Nobody should have been holding onto that that one (long-term, short-term, any-term).
"Stocks outperform most assets over the long run. Most agree on that..."
I don't think most agree with that - I keep running into people who only want to talk about gold - maybe they just know it bugs me. :)
Or perhaps it is just during hard times like now that people find it difficult, as you point out Morgan, to hang in there and NOT sell, but even more important to double and triple down and pour as much of your cash into the equities market at exactly what feels like the worst time - now. Instead they buy gold! Gah!
When Spain colonized the New World, they shipped back so much gold and silver that it debased their currency and their empire sunk, you could say sunk under the weight of gold and silver.
Investing in profit-generating companies is so much better than investing in metals or other commodities (though I won't argue that really really good traders can probably make money in commodities - I suspect that it takes much more effort and time than I have available).
I'm very excited, actually about this company, and the analogy to the Spanish Empire, and the flood of new gold into their system is scary (history repeats)...Planetary Resources which is backed by some serious heavyweights:
Brief conceptual video:
http://www.youtube.com/watch?v=7fYYPN0BdBw
Presentation by founder and chairman of Planetary Resources:
http://www.youtube.com/watch?v=c2Nf626I6vA
And company website:
http://www.planetaryresources.com/
If only I could invest alongside Larry Page and Eric Schmidt and Charles Simonyi...in this venture! I certainly would not want to be invested in gold when their technology eventually succeeds...
Invest in people (companies) - not chunks of metal.
Duuude1
I agree completely about investing in people( companies),But humans have needs, habits,and all the quirks that make them human. They are also the backbone of all good profitable companies. In order to realize the spectrum of investing, precious metals (10%- 20%) of your investable holdings should have metal in it. Gold silver palladium, platinum and if space allows, copper.Really, copper. At least 5 tons for it to be worthwhile.
Shrewd investing can be broken down to two powerful truths:
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