In our prior post, we covered the historical, real life returns of large companies compared to bonds after accounting for inflation. We determined that you must have a plan before selecting investments. Not doing so causes you to lean on outputs that are out of your control when determining if your portfolio is working (or not). A better solution is to create a plan that guides your investment selection and directs your choices so you may progress closer to reaching your goals.
All of this is counter-initiative, as our brain is hard-wired to make investment decisions that are not always in our best interest. We have been taught, from a young age that “stocks” are risky and “bonds” are safe. The media continues to reinforce this message each day as well. Really? Safe in what regard?
Safety, in principal maybe, in the short term, but not over decades of time. This “game of life” isn’t lived day-to-day or even quarter to quarter; it stretches years. An accumulator in their 40s and 50s or distributor in their 60s, 70s, and beyond must address a plan that allows their purchasing power to last. It is NOT the safety of principal that matters, but rather the ability for your investments to keep pace with the rising cost of life. Wherever you are in your life right now, equities likely stand a better chance of helping you make your plan work versus bonds. Three percent returns cannot keep pace as life gets more expensive. Sooner or later, you’ll have to sell your bond principal in order to maintain your lifestyle. When you do, you’re cooked as your portfolio begins to shrink as the math doesn’t add up.
This is worse and more widespread today than most investors realize. The majority of portfolio investments selected today, inside employer retirement plans are target date funds. They operate by liquidating equities each year and accumulate more cash and bonds as the investor progresses towards their target date. Each year safety of principal is prioritized over future growth. This is a big mistake, one that once recognized may be very difficult to recover from. Again, it’s counterintuitive to believe that diverse, large company values are a safer investment selection in a 30 year retirement than bonds.
There is an “admission price” to pay, in order to own companies and achieve the long-term, historical returns mentioned above. Seven percent equity returns do not arrive without paying a price. That price is the acceptance of day to day volatility that we’ve recently witnessed. Do you remember the 33% decline in 31 days earlier this year?
This rapid movement in prices, in both directions, is volatility not risk. Our brain processes volatility as risk and assumes movements are always negative. In truth volatility works both ways, up and down. 2020 has been a very volatile year with company values and prices moving in both directions. This is not new, nor should it be viewed as an exception to the rule. Remember the financial crisis of 2007 to 2009? This accompanied a -57% drop in company values. How about the bear market of 2000 to 2002 when all the dot com companies fizzled? This was accompanied with a -49% decline in company values. Companies expand and contract in value over time. Great companies will become better in times of adversity and will continue their forward growth.
To achieve real life returns you must successfully re-train your brain to fight the urge to liquidate companies when their values temporarily decline. It’s in these times of declined values where investors who continue to work their plan and invest will make the biggest impact on their tomorrow. This is not natural, nor does it feel good when compared to other purchases made when prices are low.
We all enjoy purchasing clothing, houses, cars, groceries, and gas at reduced prices. Why is it then when companies decline in price we react in fear and decide to sell instead of acting like an opportunist and purchasing more while costs remain low? It’s just human nature and how our brains are wired. Human nature is a flawed investor. It takes patience and a partnership with a financial professional not to give in to uncertainty and fear, and to hold what you own. It takes even more courage and faith, with a plan, to purchase more equities when the chips are down as they were earlier this year.
Five years from now your portfolio will mirror the good or bad financial decisions made with respect to how you reacted or didn’t with the price movements in 2020. Ten and twenty years from now your income goals will become a reality by simply sitting still, continuing to invest, and rebalancing what you own over time. Allowing your plan to work and purchasing lower priced companies will reward you long term. It may be another ten years or so before we see uber low prices like we’ve witnessed this year.
Time matters, and to make the most of it takes a partnership between you and a financial professional. If you’d like to discuss this further, or get a second opinion without cost or obligation, please reach out to us below as we’d be happy to chat with you.