What Worked in the 90's Could End Up Failing You Today
It is important to recognize the impact that the 80's and 90's had on the beliefs of investors today. It was during that time that the mutual fund industry went from 436 funds in 1980 to over 16,000 funds today. The availability of real time information was powerful.
Another significant institution was created during that time period. The early 80's brought us the 401K plan. Ted Benna who is often referred to as the father of 401k, started the first 401k plan back in 1980. As of 2001, the 45th Annual Survey of Profit Sharing and 401(k) Plans reports that 937 profit sharing and 401(k) plans hold over $225 billion in plan assets.
Also during that time the S&P 500 increased from a value of 114 to a high in 2000 of 1,517. It seemed easy to make money during that time period. It appeared that we could rely on the stock market to deliver us to financial freedom and 12 to 15% returns a year would be the norm. In 2000, things dramatically changed.
During the decades of the 80's and the 90's, today's investor was born. There is a great deal of significance to that statement. Your understanding of that significance is critical to your future investment success.
Today's investor grew up in an era of prosperity. Through that period, belief systems were formed. The 5 trillion dollar mutual fund industry reinforced those beliefs. The idea was to stay invested at all costs because these investments would eventually take care of you. Time is on your side. The financial services business has a lot to loose if investors stop believing in the stock market as the ultimate solution 100% of the time.
Those investment beliefs made sense in the 80's and the 90's. However, the 80's and the 90's are not truly representative of how the investment world works. Times have changed. Most importantly, the environment has changed. What worked in the 90's does not necessarily work today. Thus, it is critical to adjust your belief systems.
The popular belief of the 90's was that you always buy and hold investments and never attempt to time the market. There are many statistics that would show the benefits of buy and hold investing. Unfortunately, the whole story is not told.
A Barron's article in the fall of 2001 published an article that showed what an investor would have made if invested in the S&P 500 index from February 1966 through October 2001. During that 36-year period, an initial investment of $1,000 would be worth $11,710.
A study done by Birinyi Associates performed a compliment study to the one in Barron's. They stated that if an investor missed the five best days every calendar year, that the $1,000 would have shrunk to $150.00.
Now, the second part of their research went the opposite way. What if the investor had been invested in all but the very worst days in those years? The $1,000 would have grown to $987,120.
Merriman Capital management sites another research study. "If you invested $100 in the stock market in 1926 and simply kept your money there through 1993, your investment would be worth $80,000. If you tried to time the market and "missed" the 30 best months, your $100 would have grown to only about $1,200."
In the same study, they ran a study where you were invested in the same time period and missed the 30 worst months. That initial $100 would have grown to $8.6 million.
I feel one of the greatest risks today (in a long-term bear market) comes from buying and holding investments with the notion that everything works out in the end.
A 30% gain in the market is great. Unfortunately, it only takes a loss of around 23% to wipe it completely out. If there was overwhelming evidence that supported the notion that the worst was behind us, then the probability of a 23% loss is much smaller.
Unfortunately, there is a greater stack of evidence that would suggest that the worst part of this long-term bear market might still be in front of us. For that reason, pro-active money management might be the better answer than just buy and hold for the long-term.
Proponents of buy and hold make very good points in their argument. I have one major problem with their theory.
You might not have the luxury of recovery at the point that you actually need the money. Just ask any retiree who bought and held if it was effective for them between 2000 and 2002. I realize that advocates for buy and hold also reinforce that it is important to diversify your investments and not have all of your eggs in one basket.
Unfortunately, the mutual fund industry does not quite effectively communicate this in their marketing material. They imply that the stock market works for the long-term as long you stay invested.
I can give you 7 trillion reasons why the mutual fund industry does not talk about history.
If you go back through the entire history of the stock market, it has always recovered. You can look at charts that show the performance of the DJIA from the 1920's until today and you will see a line that only goes up. We are bombarded daily in the financial press and financial services marketing material that the market always comes back.
The material will read, "Hang in there. The long-term average of the stock market is 10%. Stocks are for the long-term. They have up and down days. Just let the market work for you in the long-term. You do not want to miss the next rally in the stock market." Before I was led to the story that history tells, I believed that wholeheartedly.
The marketing arm of the financial services industry has a powerful effect on the paradigms of investors. Here is a truth about marketing. You can always make numbers tell the story that you want told. However, most marketing pieces only tell one story. It is the part of the story that supports the main point. As a prudent steward, effective decision making starts with knowing both sides of the story. It is not until you have the pros and cons that prudent decisions can be made.
Here are some great illustrations and the rest of the story.
"Stock Market has been up 69 years and down only 32 years...
Patience May Help Investors Survive Market Swings."
A mutual fund company states that the stock market has reached positive annual returns in 69 years and has registered more than twice as many up years as down years. So, the stock market has been up 69 years and down 32 years. Then they say that "Patience May Help Investors Survive Market Swings." Ironically, they don't talk about what those 32 down years did to the bottom line.
The following chart will illustrate this point.
| If you lose: | % required to break even |
| - 10% | + 11% |
| - 20% | + 25% |
| - 30% | + 43% |
| - 40% | + 67% |
| - 50% | + 100% |
| - 60% | + 150% |
| - 70% | + 233% |
It is important to have twice as many positive years. In a long downturn, there is a good possibility that you are going to need as many more positive years to recover from the damage brought on by the negative years. Many will think that it takes a gain of 30% to compensate for a loss of 30%. It actually takes a gain of 43%. The NASDAQ was down more than 70%. It would take a gain of over 233% to recover to the March highs of 2000. It takes a great deal of years to make up for the down years. The down years are much more significant than the up years.
I want to leave you with one final illustration.
Suppose that you are from another country far and remote from the USA. The temperature in your native country stays cold year round. This is the only element that you understand. You decide to move to Minnesota. You have always heard that Minnesota was very cold. You felt pretty comfortable moving to a cold environment. You really never heard anything about Minnesota being warm. You arrive in October and everything in your wardrobe is for cold weather. You understand that it is important to always wear your gloves, coat, and hat when you are outside. You arrive in Minnesota and it seems a lot like home.
As long as it was cold, you were comfortable. That is what you believe to be true about Minnesota. You know that it is always important to be protected. Something happens that you did not consider. It actually started warming up. You find yourself uncomfortable in all of your cold weather gear.
You then realize that there are seasons in Minnesota. Now, you have to start thinking about living in warmer weather. This would require you to consider the differences between winter and summer.
Now you can stick with what you know. You could wear warm clothes year round. However, you are going to be very uncomfortable. Therefore, it would make sense to consider the differences and adapt accordingly.
Consider that the market is seasonal. There are hot months (bull markets) and there are cold months (bear markets). Sometimes we do not experience different seasons. One year might bring us a short spring and very long summer. We might have just a few weeks of fall and a brutal cold winter.
This would require you to have different attitudes and strategies because the seasons have changed. We are accustomed to one season in the market. As investors, we know and understand long-term bull markets. That was our "up-bringing." Most do not understand that seasons change. When those seasons do change, it is important to change your belief systems as well.