In January 2000, the S&P 500 Index hit 1,498. Today, as I write these words, it sits at exactly 1,450.
You don’t need to be a rocket scientist to realize this isn’t exactly a stellar rate of return for all those investors who have waited patiently these past 12 years for a little green ink to finally make an appearance on their balance sheets.
Now, it’s true that I’m painting the most pessimistic picture possible. The 1,498 peak in 2000 was exactly that: a momentary peak. Just five years before, for example, the S&P Index stood at around 500. So if you were calculating your return based on the past 17 years instead of the last 12, that 1,450 suddenly doesn’t look quite so bad.
But let’s stick with the most pessimistic view for now. Let’s say you bought into the market right at the very top of that peak, and you’ve been waiting in vain ever since for the market to make its way back up to its previous heights. Your instinct might be to look back at this financial train wreck, and decide there’s no good reason why you would ever want to throw more money down that particular drain.
Unfortunately, in this instance, your instinct would be dead wrong. There are actually several very good reasons why now is, in fact, quite possibly the single best opportunity any of us will ever see in our lifetimes to put as much money as we can back into equities. Let me tell you just a few of them.
First, you are probably going to live a long time. Statistically speaking, even if you are closing in on retirement age, you probably still have a long investment timeframe stretching out before you. And nothing performs better than stocks over long periods of time.
The average retirement age today is 62. But a typical married couple (if they are both non-smokers) will see at least one them live to reach 92 years of age. Plus life expectancy keeps going up, so don’t be surprised if lots of us start seeing triple digits in as little as 30 or 40 years’ time.
The fact that we’re all going to live much longer than previous generations could have ever imagined is great news. The bad news is the impact inflation could have as a result of those longer lives, in decreasing our real buying power over the next several decades.
With today’s long lifespans (and ever-longer retirements), inflation has become by far the biggest risk investors face, easily surpassing the risks posed by simply preserving our existing capital. If a dollar today is worth less than a dollar tomorrow, imagine what it will be worth 30 years from now.
The problem with risk is that, when people think about it, they don’t really make the distinction between the risk of a decrease in their principal (i.e. the number of dollars they have in their savings account), and the risk of that same principal having dramatically less buying power as inflation eats away at it over the years.
To most investors, both of these things feel like the same plain old risk. Since they don’t like risk, they do their best to avoid the idea altogether. But if we want to keep our buying power intact for the next quarter-century or more, we need to bite the bullet and distinguish between these two very different types of risk.
Let’s start with the risk of a decrease in your current principal. Preserving your principal means not doing anything that allows the number of dollars you own to drop. The only way to do that is to stuff those dollars in your proverbial mattress, put them in a savings account paying less than a tenth of a percent a year, or bury them in a shoebox in your backyard.
In the short-term, this can feel like you’re completely avoiding risk. After all, your capital will never go down, right? So that’s zero risk! In the long-term, however, this seemingly safe approach actually comes with a 100% risk that, when you dig those dollars back up in 20 or 30 years, inflation will have eaten away almost everything you worked so hard to earn.
Now, if we frame the question as “how do I preserve my buying power for the next 30 years” instead of “how do I make sure my number of dollars never gets smaller from one year to the next,” we come up with some very different solutions.
The reason for this is the simple fact that the short-term risk of all those market ups and downs is precisely why a diverse stock portfolio grows over time. No volatility would mean no short-term risk. But it would also mean no long-term rate of return.
If your goal is to preserve your buying power over a long period of time by making sure your investments grow enough to compensate for income withdrawals and inflation, then the short-term fluctuations in market value don’t really matter. On the other hand, if you’re determined to preserve your principal at any cost by only buying investments that are guaranteed never to go down in value, then you’re setting yourself up for several decades of missed opportunity – and missed growth.
Remember 1982? That was 30 years ago, when a house cost $69,000 and a new car cost about $8,000. If you had taken $69,000 in 1982, put it in a savings account and lived off the interest, today, you would have exactly that same $69,000 left in your account to buy a new home. Congratulations – and be sure to let me know how you like living in that lovely tool shed in the woods!
On the other hand, if you had put that $69,000 in the S&P 500 Index in 1982 and lived off the dividends ever since (which would’ve paid substantially more per year than the savings account interest anyway), you would now have around $897,000 sitting in your portfolio. And that’s including the past 12 years of zero returns.
What all investors need to know more than anything else is that a broad, diversified portfolio of stocks is really bad at preserving your number of currency units in the short term, but really good at preserving your buying power over a lifetime.
Stocks move up and down in value all the time – typically 17% in the course of an average year, and up to 50% downwards in a bear market, which tends to occur about once every five or so years. To put it another way, you could start the year with $100,000 invested in stocks, and sometime in the course of that year, your $100,000 could be worth $83,000 (or much less).
If you define risk as never having your principal decrease, then clearly, stocks are a non-starter. But if you change your definition of risk to mean preserving your real buying power over a very long period of time, then stocks will always make a great deal of sense.
Given the decades-long retirement most Canadians have waiting for them, your answer to the question “why would I add more money to this market” will depend entirely on which risk you want to manage.
We’ll be delving a little deeper into this topic on November 21, when I’ll be giving two seminars (one at noon and one at 4:30) on the topic of “Planning Your Retirement Income: The Role Bear Markets Will Play In Your Retirement.” If you’d like to join us, please e-mail Iain for details at firstname.lastname@example.org
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.