There’s no doubt that 2015 was a frustrating year for many investors: With stocks, bonds, cash and commodities all flat or down, there was almost no way to make money in the markets. And 2016, thus far, has been no peach, with global markets1 off over 6% year-to-date as of the close on Wednesday (January 13, 2016).
However, last year’s anemic returns looked as dismal as this year’s in August and September – until they recovered in October, regaining much of the lost territory.
It’s this disappointment that is exactly why long-term investors need to continue to exercise discipline. Let’s face it: with account balances stagnating and market pundits churning out investment tips for the year ahead, it can be tempting to change horses mid-stream. But history shows how costly impulsive decisions of this kind can be.
Consider the 2008-2009 market crash. If you sold the iShares MSCI ACWI exchange-traded fund (NASDAQ:ACWI) in March of 2009—the bottom of the crash—and bought back into the market at the end of 2009, when a recovery was clearly under way, you would have a gain of almost 24% today. By comparison, investors who kept their money in the ACWI would have a gain of over 100%.
Granted, 2015 was nowhere near as scary as 2008 and early 2009. However, 2016 is starting off on a less than enjoyable note. As a result, many investors still have a propensity for poor decision-making that comes from judging their performance in the wrong ways. A typical mistake is evaluating performance over short increments of time. Isolating performance into a timeframe starting January 1st and ending December 31st is purely arbitrary, when you think about its relevance to your life. But that’s what most investors and the media tend to do.
Because 2015 was a challenging year for the broad equity markets, and with 2016 starting off similarly, some investors may want to shake up their portfolios and make a “fresh start.” But these sorts of tactical zigzags often lead to poor long-term performance and place your financial goals in jeopardy.
A 2014 study2 by State Street Corp.’s Center for Applied Research concluded that a lack of discipline helps make it nearly impossible to achieve both high returns and long-term objectives. “Investors are very short-term oriented in the sense of how the markets are performing,” Suzanne Duncan, who headed the study, told The New York Times. “It’s all relative returns. That takes away from their ability to stay the course.”3
Stepping back from a focus on 2015 provides clarity and perspective. Over the past three years, the S&P 500 Index gained an above-average return of about 15%. Over the past five years, its annualized average is about 12%; which is right in line with historical returns.
Focusing on inappropriate time periods is just one of the key mistakes investors make in evaluating performance. As State Street found, they also tend to measure performance against outside markers rather than their own goals. The study found that just 29% of investors defined investing success as reaching their long-term goals. Most defined success in terms of short-term comparisons such as how their portfolio fared versus a benchmark.
To beat market benchmarks without taking additional risk – also known as achieving “alpha” – many investors turn to fund managers with a reputation for stock-picking skill. But as the State Street study pointed out, relying on active managers to outperform is wishful thinking. In 1990, 14% of U.S. stock mutual funds beat the market through skill rather than chance. That low percentage had shrunk to nearly nothing by 2006, when just 0.6 percent of funds delivered true alpha. The mid-year 2015 SPIVA® Scorecard4 supports this research, stating that “over the five- and 10-year investment horizons, 80.8% and 79.59% of large-cap managers, respectively, failed to deliver incremental returns over the benchmark” and “it is commonly believed that active management works best in inefficient markets, such as small-cap or emerging markets. This argument is disputed by the findings of this SPIVA report. The majority of small-cap active managers consistently underperformed the benchmark in both the 10-year period and each rolling five-year period since 2002.”
That hasn’t stopped Wall Street from trying to top various market indexes: Duncan’s study found that financial firms spent 60% of their capital expenditures in the quest for short-term outperformance. There’s a powerful financial incentive for this game of needle-in-the-haystack: In 2014 alone, active asset management firms earned $600 billion in fees—an amount which approaches the gross domestic product of Switzerland.
Impatience and the siren song of promises to beat the market have led countless investors astray. In one State Street survey5, 73% of respondents said they invested to meet long-term goals like financing retirement and passing money to heirs—but only 12% expressed confidence that they were actually prepared to meet those goals. That’s what happens when a short-term investing focus takes precedence over long-term goals.
The path to successful investing begins with creating a portfolio based on your unique goals first, then assessing your comfort level with the associated volatility, and – most importantly – sticking with it through the markets’ ups and downs.
If you believe in capitalism, then over long periods of time, stocks will better bonds, and bonds will outperform cash. Keep your real time period in mind. For many its decades, if not generations.
The past year was bumpy, but the way to reach your destination is to stay on course.[/fullwidth_text] [fullwidth_text alt_background=”none” width=”1/1″ el_position=”first last”]