Investing shares a lot of similarities with sports. Good decisions often lead to bad outcomes and vice-versa. [Note that I'm skipping his introduction about sports, since that doesn't interest me.] ...
One of the most important contributors to successful long-term investing is asset allocation. Investors evaluate the tradeoff between higher returns on riskier assets, such as stocks, and lower returns on more stable assets, such as U.S. Treasury bonds. In constructing a portfolio, they try to balance their desire for maximum returns with their ability to withstand volatility. Long-term data clearly demonstrates that stocks, though more volatile than bonds, have rewarded investors with higher returns. Statistics compiled by Ibbotson Associates show that since 1926, stocks have produced an average annual return of 10% while U.S. Treasury bonds have returned less than 6%. Long-term investors in stocks have been well rewarded for accepting the risk of short-term loss. Obviously, if one could avoid owning stocks in the negative years, one’s return would be even higher (and one’s risk would be lower) than if one used a buy-and-hold approach. With this in mind, many investors attempt to time their investments in stocks. But almost every study has concluded that trying to time the market is futile for most investors.
And yet, despite all of the evidence that stocks are the highest returning asset class over the long term and despite all of the evidence that almost nobody can time the market, the financial media usually treats bears as being more thoughtful than bulls. This is a pet peeve of mine because I believe it is a disservice to individual investors. Much like with Monday morning quarterbacking, investors need to consider the probabilities. Since the stock market has to either go up or go down, you might think this is a 50/50 proposition. However, the S&P 500 Index has had 24 down years since 1926; in other words, in 88 years, only 27% of the years have produced a loss. The probability of a down year has been about the same as the probability of an eight-point underdog winning a football game. It happens, but it isn’t a bet you’d make unless you got good odds. In short, history shows a much higher burden of proof is on the people who predict that the market will fall, rather than on those who predict it will go higher.
When we look back on the S&P 500 gaining over 30% in 2013, it will seem like owning stocks was an easy call. The market had been moving higher in preceding years, valuations weren’t demanding, and the economic recovery was still quite young. But the bears argued that it was foolish to invest after stocks reached a new high in March. They argued that slowing growth in China threatened our economic recovery and that it was too risky to invest when our government was so dysfunctional that it shut itself down. Additionally, they predicted that the Fed tapering would bring a screeching halt to the positive returns. As Gilda Radner’s Saturday Night Live character Roseanne Roseannadanna said 35 years ago, “It just goes to show you, it's always something--if it ain't one thing, it's another." There has always been something for investors to fear, not just last year but every year, yet the market has averaged a 10% annual gain and has gone up in 73% of the years since 1926.
Let me start by saying that there's one thing I don't like about his comments. He seems to be defining "risk" as "volatility." The fact is, when you're an investor, there are all sorts of different risks. But for someone like me, volatility is almost completely immaterial.
Unless I'll be forced to sell when the stock market is down (and I think I've taken prudent steps to counter that possibility) or I'll panic during a market crash (and given that I got through the 2008 economic collapse just fine), why should volatility concern me?
Sure, I'm human, and I hate to see my investments decrease in value - especially since they normally go down a lot faster than they go up (though not nearly as often). But volatility isn't a big risk for me,... and I've got some very volatile holdings.
However, there are two points he made which I really liked. First, good decisions don't always lead to good outcomes, especially in the short term. And bad decisions can make you money,... sometimes.
It's always valuable to look back at the decisions you've made and see what the outcome was. But just because an investment decreased in value, that doesn't mean your decision was wrong - not given what you knew at the time. You have to look at it more closely than that.
Now, sure, you might always be tempted to say that you were right, that it was just the stupid market that was wrong. But sometimes, that's true. More generally, you can make all the right decisions and still be disappointed in the outcome. That's because you can't predict everything (and you should certainly know that).
This past year, the stock market has boomed. If you were in the market at all, you probably felt like a genius. But that's probably not the case. And you're not going to learn to make better decisions if you don't recognize that.
Yes, look at the past. Look at the recent past and look at the long-term. Look at how your decisions have turned out. But also remember why you made those decisions and look at whether your reasoning was valid, however the results ended up.
If I bought a lottery ticket and actually won the lottery, would that mean that buying lottery tickets was a good idea? Sure, it worked out for me that time, and I'd be very happy with the result. But if you look at the odds, it was still a bad decision. (Note that I've never actually won the lottery - or even bought a lottery ticket.)
It can be the same way with investing. You can have good results without making a good decision. But I wouldn't bet on it happening regularly. Likewise, just because you lost money, that doesn't mean your reasoning wasn't sound. It could be that your reasoning wasn't sound, and I'd examine that possibility very carefully. If you keep losing money, I suggest that you've probably overlooked something. But it doesn't have to be that you made the wrong decision.
The second part of this is to remember that the stock market goes up over time. Maybe that will end someday, I don't know. (If it does, we'll probably have bigger things to worry about than our stock market portfolios.) But so far, the stock market - over the long term - has been the closest you can get to a sure thing. If you stay invested long enough, you'll make money.
My holdings generally go down a lot faster than they go up, but they go up far more often. This past year has been especially great, unusually great, and the past five years (despite a down year in 2011) has been absolutely incredible. Of course, that's because the economic collapse at the end of the Bush Administration was so severe that we were at a very low level five years ago. I really don't expect another investment opportunity like that in my lifetime.
But what about this year? What about 2014? I have no idea. A down market wouldn't surprise me in the slightest, but an up market wouldn't really surprise me, either. (Another year like 2013 would surprise me, but look at the late 1990s if you don't think that can happen.)
The thing is, if you bet that the stock market will go down, you might make money. You might even make a lot of money. If you're right. But the odds are against you, because the long-term direction of the stock market is up. That's gambling, not investing.
I'm not a gambler, because I don't like to make bets where the odds are against me. If you buy a lottery ticket, you might win big, but it's a lousy bet. If you go to a casino, you might come out ahead, but it's a lousy bet. Casinos don't make vast sums of money because your odds of winning are good. Just the reverse, in fact.
But your odds are good if you invest in the stock market and avoid making stupid mistakes. (Many small investors do make stupid mistakes, of course. I've done it myself. I probably still do. But that's not what this post is about.) But long-term investors have the odds on their side, which is the exact opposite of gambling.
(I might also point out that investors have the government firmly on their side, too, since most investors are wealthy. Investors pay far lower taxes than people who work for a living, and there are an abundance of ways to avoid taxes altogether. Most of those government policies help the wealthy more than you and me, but we can still take advantage of them.)
At any rate, the stock market will go down someday. And the fact that 2013 was such a boom year (following a great year in 2012, too) probably makes it more likely that 2014 will be down, just because prices are higher now. But will last week be the start of a bear market? I have no idea.
I'm definitely cautious (well, as cautious as I get, which isn't very). I've made a few minor adjustments to my portfolio. But as they say, markets climb a wall of worry. The time to get scared is when that stops, when everyone seems to think that the market will continue going up. Except for those times of "irrational exuberance," I'd just consider such worries as little more than noise.
Over the long term, the odds are in your favor. In the short term, well, who knows? Not me. And not anyone else, either. (You can guess and get it right. But what does that really tell you?) Bears have the odds against them. They can still make money, just like you can still make money in a casino, but it's not easy. (Besides, successful bears tend to focus their picks on individual stocks, not the market as a whole.)
Maybe it's a personality quirk, but I don't like gambling. I positively hate the idea of betting against the odds. That's a sucker's game, and I don't want to feel like a sucker. So I don't gamble. I risk my money, yes. I take on a lot of risk - more than most people would feel comfortable with. But I always want the odds on my side.
No comments:
Post a Comment