The Bumpy Road to the Market's Long-Term Average

Once in a rare while, there comes a year in the economy and markets that serves as a master class in the principles of successful long-term, goal-focused, planning-driven investing. Last year, 2020, was one of them. The year reinforced some timeless investment lessons:

On average, the largest stockmarket in the world and one our clients have substantial exposure to - the U.S Stockmarket (as measured by the S&P 500 Index) - has declined by about a third every five years or so since the end of WWII. But in those 75 years, the S&P Index has gone from about 15 to 3,756. The lesson is that, at least historically, the declines have been temporary and long-term progress has always reasserted itself.

In 2013, there were 45 new all-time highs for the S&P 500 and it ended the year up more than 30%. Does anyone recall anything special about 2013 now to explain this? No, me neither. Markets reaching new highs is not a cause for alarm - you expect it over time. Following 2013, there were 53 new highs in 2014, 10 more in 2015 and an additional 18 in 2016 [1].

Yet, your investment experience will inevitably be bumpy. Though the S&P 500’s long-term return has compounded at an average 10%, in only six of the past 95 years has its annual return been within two percentage points of 10% (i.e. between 8% and 12%). Yearly returns have ranged as high as +54% and as low as -43%. Since 2013, the S&P 500 has experienced falls of -12%, -13%, -10%, -20% and -34%. Yet each time the market has come charging back to new highs. Note, there have been 70 years of positive annual returns and only 25 negative years.

Investing is always hard no matter the environment. It’s hard when stocks are falling because losing money is painful and it always feels like stocks could fall further. And it’s hard when stocks are rising because you have to balance the FOMO that comes from watching others get richer than you with the worry any day now could be THE top.

Over longer periods of time, bumps in the road on the journey toward our goals tend to smooth out. As investment advisers and financial planners, we think in decades at a time, including retirement which averages three decades. This chart below shows the history of 30-year retirements using the S&P 500’s compounded average annual return over those golden years:

The History of Retirements

For 30-year retirements that began in 1926 through 1991, the S&P 500 returned a compounded annual average of no less than 8.5% and as high as 13.7%, averaging 11.2% over those sixty-six 30-year periods.

Looking Ahead

Looking forward to 2021, a big question on the minds of many investors is, “Why do I own anything but those five big tech stocks (being Amazon, Facebook, Apple, Netflix and Google) which have done so much better than the S&P 500?” These five stocks alone have also dampened the value premium over the past decade, leading some to wonder if the value premium is no more?

The problem with this thinking is it assumes past out-performance will continue into the future. This is usually based on a good story about the company, but that same information is known by the entire marketplace so at any given point it is already baked into the high price of the company. This thinking is also usually based on a speculation that what has been hot will continue to be hot, what behavioural economists call “recency bias.” 

History is not on the side of investing in just the big-name companies. As this illustration below shows, the largest companies change significantly and unpredictably from decade to decade, and half of the current big ten companies are new (and therefore relatively unproven) members of the club. 

Largest 10 US Stocks at the Start of Each Decade

Source: Dimensional Fund Advisors

There is no way to construct a reliable plan from this chart, whether for a lifetime investor or just a 30-year retirement. By contrast, the predictability illustrated in the first chart is something we can make a plan around with a high likelihood of success. Acting on that plan (instead of reacting to markets/events/news) through all the fears and fads of a retirement or an investing lifetime helps us avoid sudden emotional, and costly, decisions. So, let 2021 be the year we take three deep breaths, reassess where we are at, rediscover our most important goals, and update our financial and investment plan to align to our deepest values.

 

Most of this article has been reproduced by consent of Abacus Wealth, a member of the Global Association of Independent Advisors along with Stewart Partners

[1] Source: The Investment Strategy That Makes Your Life Easier, by Ben Carlson 9 February 2021

Brendon VadeAll, Investment Education, Living a Better Life