Written by Ethan S. Braid, CFA on 8.21.2015
The last two days have seen both the Dow Jones Industrial Average and the S&P 500 decline by about 6%. If you watch the news, read a paper or scan the internet, you might be convinced that the world is about to end! Fortune tellers are coming out of the woodwork, making all sorts of predictions and the news headlines sound ominous. A sample of today’s ridiculous headlines at 6:22pm mountain time:
- Boom Goes Bust: Dow -530
- Trading Meltdown Dow Drops more than 500 pts, biggest loss since ‘11
- Growth Fears: Stock Slide Wipes out $1.4 Trillion, Big Money Investors in ‘No Man’s Land’
- Markets in Turmoil: CNBC Special, Sunday 7pm ET
- Cramer: We need leadership now
- Market Correction not over yet: Bob Doll
- Dow Plummets 531 Points
- Market ‘aftershocks’ are coming: Robert Shiller
With this level of media hype, unwarranted fear, and overall noise, I thought it would be helpful to share some rational thoughts with investors.
Don’t Ignore the Base Rate.
Nobel Prize in Economics winner Daniel Kahneman and the late Amos Tversky (Tversky helped contribute to the work that earned Kahneman the Nobel Prize but was not alive when the award was given) taught us that people routinely ignore base rates and often gravitate towards predictions that are in direct conflict with base rates, even when the subject knows the base rate. What does this mean? According to Dr. Jeremy Siegel’s research, between 1802 and 2001, the stock market had a nominal compound annual return of 8.30% and a standard deviation of 17.50. Therefore, we know that the base rate for the stock market is a little over 8%. With 200 years of data to look back on, we would expect that 95% of the time (i.e. what we consider “normal” – the range of returns within +/- 2 sigma), the stock market should provide an annual return between -26.70% and +43.30%.
So now that we know that it is “normal” for the stock market to be down as much as -27% and up as much as +43% in any given year, why would we have any concern over the fact that the S&P 500 is currently at -4.27% year-to-date? Would it be even remotely logical to sell your stock market investments and try to predict the future based upon the last two days of selling?
You Cannot Expect Consistent Short-Term Gains from Long-Term Holdings.
One of the biggest mistakes I see investors make: mismatching investment performance expectations with investment time horizons. The stock market is a long-term investment and there are no exceptions to this rule. When I say long-term I mean greater than 10 years. Unfortunately, we have developed a culture that is fixated with day-to-day and month-to-month investment gains or losses. Utter nonsense that often influences investors to make terrible decisions. If you want to earn 8%, 9% or even 10% compound returns, you must be committed to leaving your money invested for a minimum of ten years. Along the way, there is a high likelihood that you will be negative at some point, maybe even for a few years or longer. The good news? According to Morningstar, when analyzing all 120 month (10 year) rolling periods between 1926 – 2013, 94.30% of the time an investor had a positive return at the end of ten years. Take away: If you hold your stock market investments for a decade or longer, you have an extremely high probability of making money.
You Cannot Consistently Time the Stock Market.
No-one knows what the market is going to do in the next few days or months. Some people correctly guess, however, they are merely speculating and nothing more. Research by Morningstar has shown that by taking the 10 best trading days from the twenty year period of 1994 – 2013, the nominal annual return drops from 9.20% to only 5.50%. Missing just 10 days out of a 20 year period decreased your return by 40%!
Stay rational. Stay invested. Pay attention to base rates, they matter. Match your investment return expectations with the proper hold time for the investments you own. Don’t try to time the market. Ignore the emotionally charged headlines designed to make people panic. Always remember, Wall Street makes money when you buy and sell but that doesn’t mean you are going to make money!
Ethan S. Braid, CFA
HighPass Asset Management
800 – 672 - 7916
About the author of this article.
Ethan S. Braid, CFA is the founder of HighPass Asset Management – an independent, fee-only, registered investment advisory firm with a fiduciary duty to the clients it serves. Mr. Braid has been passionate about managing client investment portfolios and providing customized financial planning advice since he started working in the investment industry over 16 years ago. Mr. Braid earned a BS in finance from Robert Morris University, an MBA from Cleveland State University and he is also a CFA charterholder. The CFA program is a graduate level, globally recognized, multi-year program with a focus on investment knowledge. Candidates for the program commit an average of 900+ hours of cumulative study time to complete all three levels.
Mr. Braid is devoted to being an expert in the field of wealth management for high net worth individuals and families and for many years, has read one book per month on subject areas such as: estate planning, retirement planning, investment analysis, mergers & acquisitions and behavioural finance. Mr. Braid also has a passion for business history with a focus on the late 19th & early 20th centuries. To date, Mr. Braid has read 63 books on the subject areas above.
When Mr. Braid is not helping clients, he enjoys: cooking, wine, exercise, his yellow Labrador retriever, fly fishing, hiking, travel, playing guitar, snowboarding and duck hunting. Mr. Braid is a committee member of the Denver Chapter of Ducks Unlimited.
This article is provided by HighPass Asset Management for informational purposes only. No portion of this commentary is to be construed as a solicitation to buy or sell a security or the provision of personalized investment or legal advice.