Benjamin Franklin was not talking about our investment portfolios, but he might as well have been.
Many investors know that the US stock market has averaged an approximate 7% return per year since its inception. Compounding that figure—or any positive one really—over a number of years will look great in a spreadsheet projection. The logic is that in X amount of years, you will be sitting pretty and have that much more money.
In actuality, returns will deviate from that expected return. In fact, they will vary greatly. I would say that they will stray from the norm, but the truth of the matter is that there is no real norm. Every forward-looking decade, year, month, week, day, hour, minute, second, and tick of the market is a complete unknown. I analyzed some data using Portfolio Visualizer for VFINX, a Vanguard mutual fund that tracks the S&P 500 Index. As you will see on the annual returns chart below, there is no distinguishable pattern.
Lumpy returns aside, it is still not their unevenness that throw market participants off track. Random returns are tolerable. It is the scary drawdowns that do the trick. When volatility rears its ugly head, many investors run for the sidelines—often at the worst possible time.
Although it might not seem like it lately, these dips in the market happen frequently. When you login to your accounts or check your statements, you understandably want to see a higher balance than you’ve ever seen before. It just doesn’t always work out that way. In a 2015 study, Marotta on Money calculated that in 6.96% of market days the S&P 500 hits an all-time high, which is about 25 days a year. This leaves your investments in a drawdown state roughly 97% of the time, as the graph below demonstrates.
By the same token, it is only human nature to judge your portfolio against its high-water mark. And when you lose money, it hurts. Even the most fortunate people—ones with no need to draw income off of their portfolio—will need a strong stomach to stay invested through the inevitable rough patches.
So is there a better way? While it is important to know how much your investments are worth, I encourage my clients to take a different approach by a