Time is a funny thing.
Some days, it can feel like you have all the time in the world. Other days, it seems like our lives are speeding by at a pace that would put Mario Andretti to shame. Unfortunately, far too many investors adopt the same kind of paradoxical – and counter-productive – approach to their relationship with time.
In theory, the vast majority of investors accept that a well-balanced portfolio of stocks will do very well over the long term. This shouldn’t come as a surprise to anyone. The evidence, after all, is pretty overwhelming. Over a long enough timeframe, most active money managers and stock traders will fail to beat even the simplest index funds, purchased once and held onto until retirement.
When I first joined the financial services industry back in 1984, for example, the TSX composite index stood at 2,200 points. Today, it’s sitting around 12,500. That’s a more than fivefold increase, and it doesn’t even take into account the extra bump that could’ve come from reinvested dividends.
Down south, the S&P 500 has performed similar mathematic gymnastics over the past 30 years, growing from 150 points in 1984 to its current height of 1,400. Yet while most investors aren’t particularly surprised by these kinds of numbers when it comes to 20- or 30-year periods, for some reason, we still can’t seem to resist the urge to micromanage our equity investments by the month, week or even on a daily basis.
Don’t believe it? Just pick up a newspaper or turn on BNN. The financial press is filled with recommendations of what stock to buy in anticipation of some future event. When that “sure thing” doesn’t come to pass, we absorb the loss without a second thought, and start looking for tips on the next great thing.
This stopgap approach of trying to predict or time the market is, in my opinion, the single greatest risk to most investor portfolios. It leads to a pattern of buying high and selling low. It also dramatically increases the likelihood that you’ll miss out on all the biggest gains, which usually tend to happen right when all the “experts” least expect them to occur.
To make matters worse, the longer those active investors keep trying to beat the market, the more likely it is that they will fall behind even the most conservative passive benchmark. This means that not only do most of those investors have very little chance of beating the market over time. They’re also likely going to lose a whole lot of money trying to do it.
So what drives us to keep trying to beat the market, when the numbers seem to suggest that doing so is a recipe for disaster? For most investors, it’s the perception that they haven’t made any money in the market. The flaw in this line of thinking is that, while they’re right about not having made any money, they’re wrong in trying to blame the market for their problems.
The market doesn’t care what we or the pundits think. In the short term, it moves erratically, responding to all kinds of random variables that no one can anticipate. But over a long enough time period, it reflects the growth in earnings of all the companies whose stocks it represents.
Investors, on the other hand, care deeply about what happens to their hard-earned savings. They want to see their investments grow each and every day, and the idea that what happens today won’t have any lasting effect on the value of their holdings 30 years from now offers little emotional comfort when their numbers begin to slide.
This emotional attachment can lead to all kinds of potentially disastrous behaviour, like selling low because we get nervous when our portfolio takes a temporary decline, or buying last year’s winning stock at a premium price under the misguided hope that lightning will strike the same place twice.
In the late 1980s, for instance, I had several clients who looked at the handsome gains they’d made and decided to sell all or most of their holdings, and get out while the getting was good. Unfortunately, they missed the massive run-up of equities in the early and mid-1990s, which would’ve seen their portfolios increase even more dramatically.
Over the past few years, investors have been selling their stocks for the opposite reason – to get out before the getting gets worse. But the impact of this decision on their long-term results is, unfortunately, likely to be pretty much the same. By sitting on the sidelines out of a fear of what might happen in the short term, they’ll almost certainly miss the boat when stocks do inevitably turn around, and start climbing once again.
For those who still don’t believe that the majority of investors follow their emotions rather than their heads, just look to what happened in the 2008 market crash.
When stocks began falling, investors flooded to the exits, driving stock prices down more than 50%. Despite these once-in-a-lifetime bargain prices, investors continued to pull their money out of the market in record amounts. Even today, as stocks sit at their lowest valuations in history relative to interest rates, investors remain reluctant to get involved.
If you were to ask one of those panicked sellers back in 2008 whether they believed that stocks would eventually ever go up again, I think most would’ve answered yes. If asked why they were selling, they would probably have said they simply couldn’t stand the losses they might suffer between now and then.
What they’re forgetting is that they haven’t “lost” anything, unless they actually do pull the trigger and sell. They’re also forgetting that the absence of growth afforded by “guaranteed” investments like GICs (or a strongbox under the mattress) is really just a guarantee that you’ll lose money over the long haul.
Inflation will reduce the value of your capital by around half every 20 years. So most people need significant long-term growth in their investments just to stand still – the kind of significant growth that can only be found by investing in equities.
The good news is, inflation is a completely avoidable enemy. A diversified portfolio of stocks, held passively for a long enough period of time, will multiply your capital enough to stay ahead of inflation, and throw in a rising dividend yield to boot.
It’s too bad so many of us have so much trouble seeing short-term risks for what they really are: speed bumps on a long road that is ultimately only going to go higher and higher.
It’s even worse that we have a hard time seeing the true long-term risks of inflation and taxation: a guaranteed certainty of failure that, paradoxically, can only be overcome by standing still long enough for the uncaring market to take care of the problem for us.
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.
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.