Smooth ride versus rocky road

For the past 20 years, the S&P has had a compounded annual growth of  about 8%.

So why people are not earning that kind of money?

In my previous article “What kind of return to expect from your money” I spoke about the DALBAR’s report which states that the average investor in the S&P 500 earns less than 2.5%.

The reason is simple. When you tell people that the stock market has earned 7, or 8 % over the past 20 years, they imagine a smooth line like the one shown in this picture.

S&P 500 returns smoothed over 20 years.

But the stock market is anything but stable. The stock market is rocky, there are sharp declines which test our confidence, our convictions that market will continue its upward trend. People see their investments drop and then they sell out. Eventually, the market starts recuperating and eventually people gain confidence and get back in.

In following this behavior people sell low and buy high, which hinders their performance.

This is a real picture of the market during the past twenty years.

S&P 500 volatility over the past 20 years.

How many people got out after a significant drop in the year 2000, 2001, 2002, only to get back in late 2003, 20004.

How many people got out at the bottom of 2008 only to get back in at the end of 2009?

The market does NOT guarantee smooth returns, the market is volatile, there are many violent ups and downs, enough to shake out the people who don’t have a strong convictions.

It is my believe that people can have the stomach to withstand that volatility under three conditions.

  1. Ignore completely the market news. Set it and forget it, and never think about it.
  2. Educate yourself enough to know that volatility is part of the market and that eventually the market will continue generating attractive returns.
  3. To have a “Fee Only” financial adviser to hold your hand on time of uncertainty. The reason why I say “Fee Only” is because commission based advisers have the conflict of interest of their commission, one of their principal motivation is to sell a commission based product with high fees.

I will share with you my own personal technique. I invest with the hope of getting a 6% return on my investment. If my investment continues producing over 6% year after year, then I am happy.

Bellow is a weekly chart of the TSX (Toronto Stock Exchange) and a 6% line. As long as my investment continues growing in excess of that line, I know I am doing well. The market might fluctuate up and down, but in the long run, I feel optimist that it will continue trading above my expected return.

The TSX has been growing at a much rapid rate than my expected return.


Eating Korean food. Jan 13

My message to investors is as follow: In the long run, stocks have higher returns  than bonds. I like to diversify my holdings by having ⅓ Canadian broad based index, ⅓ US broad based index, and ⅓ International broad based index. When you put those three together, the volatility of your portfolio will decrease and you will be better able to withstand the ups and down of the market in one particular geographical area.

Although past returns are not guarantee of the future, chances are that as long as there is a capitalistic system, stocks will continue doing well in many decades to come.

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