Written by Nate White, Chief Investment Officer of Paragon Wealth Management
This article is from Paragon’s Third Quarter Newsletter. If you are interested in receiving a free printed copy of Paragon’s Quarterly Newsletter, please click here.
Investing encompasses two of the most powerful human emotions — fear and greed. In light of the recent market volatility, your biggest fear, without a doubt, is losing money. No one likes to see account values go down. So how much should you worry about losing money with your investments? And how valid is that fear when viewed through a historical lens?
We all know investing is a long-term process. I would take that one step further and propose that the main risk is not being invested. And history proves it.
Fear of the downside prevents people from investing correctly. When markets become volatile or economic fear increases, the apprehension is over values dropping in the present moment. Often the fear is that the values will drop and never come back. No one ever wants to see their accounts drop by 20 or 50 percent — and then never recover. But when in the history of the markets have they ever not come back? Never. Even still, it is amazing to hear this irrational concern over and over and over again.
When markets drop, many people sell out or change to a more conservative allocation, thereby effectively locking in their losses. When someone sells out as the market is going down, they rarely get back in at a lower price. If you sell out when the market is down 5 or 10 percent, when do you intend to get back in? When the market is down 15 to 20 percent? Usually the fears that cause someone to sell do not subside before the market rebounds (and it often become worse). By the time the waters have calmed and the investor’s confidence has returned, the market has moved higher than the point from which they sold.
In fact, if someone doesn’t recover from a market downturn, it is usually because their allocation was overly risky going into the downturn or they changed to a conservative allocation during the slide. It’s not because the markets didn’t recover. For example, if you were overloaded on tech stocks or financials before their respective crashes in the previous decade, you probably had a hard time recovering. People tend to load up on the “hot” things during boom times only to get sorely disappointed when those assets come back down to earth.
Now back to my claim that the real risk is in not being invested. Long-term risks are always harder to confront rationally because they are not immediate concerns. In order to help overcome the fear of the market’s downside, please consider the accompanying table. It displays the historical probabilities of a profit in various timeframes for stocks (S&P 500), 10-year Treasury bonds and a mix of 20% stocks and 80% bonds from 1928 through 2014. The stock market’s chances of being up in a single year have been over 70% — and it only gets better the longer you hold. There has never been a 20-year (and nearly a 15-year) period where stocks have been down. Most people entering retirement today have more than 20 years of “investable” time. Now, I’m not recommending a 100% stocks portfolio for retirees, but the principle remains strong.
For those who are more risk averse or require a more stable portfolio, look at the figures in the 20/80 mix of stocks and bonds. It is better than even a portfolio of pure Treasury bonds in that it has had a better average annual return (6.3% vs. 5.0%) for the same amount of downside risk. This portfolio had only two negative three-year periods out of 85 occurrences and has never had a negative five-year period. Talk about putting the odds in your favor!
Not one of us has control over the market, but we do have control over letting time work in our favor. This table shows that negative periods are in such an impressive minority that they should be looked upon as opportunities — or at least ignored from an investing standpoint. Not many people wanted to invest during the 2008-2009 financial crisis — and I get it. The headlines were scary and it seemed as though the economy might collapse. But in hindsight, it was a great buying opportunity very few took advantage of.
There will always be things to worry about — and today is no exception. Consider that the period covered in the above review included the worst World War ever, a Great Depression and 12 recessions, the Cold War, numerous other wars and conflicts, oil shocks, inflation shocks, strong and weak dollar periods, debt bubbles, fiscal crises, various housing booms and busts, technology booms and busts, and both Republicans and Democrats. Despite all these hazards, the markets have moved up, reflecting the virtues of a free market and providing an effective method for investors to build their wealth. Don’t be left out!
Disclaimer Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.