The article “Your Portfolio: Maintaining Perspective” [November 2008 AAII Journal] provides several examples of historical investment returns to demonstrate the resiliency of the market. In Table 3 [Best and Worst Average Annual Returns (1945–2007)] the authors display several one-, five-, and 10-year average returns to drive home their point that an investor needs to remain in the market for the long term to achieve solid investment returns and to avoid short-term losses.
I cannot help but notice, however, that all of the “best average annual returns” are almost 10 years old. Out of 15 examples, the year 1999 is the most current year included in any of the returns—some go back as far as 1949. While likely intended to provide comfort and support to readers during this volatile period, for me, the article did just the opposite. The market of today bears little resemblance to the market five years ago, less so to the market 10 years ago, and certainly looks nothing like the market of the 1940s!
Today’s market is global in scope and includes many complex investment vehicles that very few people completely understand. Also little understood is the impact that the collapse of one investment vehicle may have on others and the impact on key businesses—look at what happened to Lehman Brothers and AIG.
My point is that only recent annual returns provide an indication of what today’s market will and will not do. The average annual return of the 10-year period of 1949–1958 is ‘nice to know,’ but completely irrelevant to today. Since 2000, the market has demonstrated dramatic volatility, high sensitivity and unexpected relationships. And I suspect we will see more of this in the future.
So, yes, I agree with the authors that you need to stay in the market for the long term. But fasten your seat belt—it’s going to be a bumpy ride.
Edward J. Kmiec, CPA, CFP
I adhere to the Markese/Scott fundamental rules [“Your Portfolio: Maintaining Perspective,” November 2008 AAII Journal] and always advise others to do the same.
However, I find it increasingly hard to make the case for equities. In the long term we are all dead (or broke) and that day is approaching increasingly rapidly, especially for the retiring baby boomers. Given that the S&P 500 has returned a mere 0.30% annualized return over the past 10 years, one would in fact have been far better off in T-bills. Neither has proved to be an inflation hedge.
The pitfalls of market timing are well rehearsed and your points about re-entry are valid. However, market timing is exclusively the game being played by the so-called professionals with their huge pools of liquidity. They have to make quarterly numbers and annual bonuses. If the retail investor had panicked out of the market at the first sign of trouble, say Northern Rock a year ago, he/she would be very happy today. In fact, she could have sold at almost any time in the first nine months of this year and been better off. You can absorb a lot of inflation erosion if you’ve missed a 30% loss.
Of course, it’s all too late now. Or is it? Maybe this time really will be different!
“Financial Professional Terms: What They Mean and Why You Should Care,” by Harold Evensky and William Reichenstein, is an excellent article (November 2008 AAII Journal). Every investor should be familiar with these issues. Knowing the details makes all the difference in the world between having a mediocre portfolio and an excellent one! Remember, the broker/advisor always gets paid, whether your portfolio goes up or down. The objective is to keep these expenses to a minimum. Two observations:
Gerry from Pennsylvania