Some investors believe their prowess in picking investments is above average because they have a good year now and then. This is similar to surveys which reveal that over 80 percent of drivers polled indicated their abilities to navigate the highways were above average (obviously only 49 percent can be above average by definition). The problem with the human ego is that we attribute successes to our own abilities and failures to randomness or bad luck.
For example, most investors, including myself, have in the past used the assumption that their stock portfolio should average about 10 percent return over reasonably long periods of time because that’s what history has shown equities have produced over the last 80 or 100 years.
Problems arise with this theory when we experience a dead decade, like we just went through, where stock returns were approximately zero. Of course, back in the decade of the 1990s the returns from stocks were close to 18 percent per year average annual return. Hmmm. Sounds like the random nature of when stocks are either good or bad can have a very large impact on the outcome of a retirement plan, and it can favor one individual while harming another. Factor in that most of us do the bulk of our saving and investing between age 40 and 65 and we are no longer working with 80 year averages on our side.
For example, people who retired in the year 2000 and were counting on long-term historical averages to provide good results while they enjoyed traveling during the first decade of their retirement, have probably had to make some adjustments to their expectations for the next 10 years.
However, someone who will retire in the year 2020 may have a totally different experience if the stock market resumes its “normal” returns in the next decade. If the 2020 retiree stayed with his/her savings and investment plan, he or she has been accumulating equities and other investments like real estate investment trust while they have been depressed in price, and may be rewarded handsomely if markets resume to their winning ways in the next 10 years – an expectation there is some historical precedent for.
Market research firm Ibbotson Associates compiled data which showed a hypothetical portfolio of 60 percent stocks and 40 percent bonds, in which $100,000 was invested in 1946, would have grown to $1.15 million in 1976 (a 8.48 percent APR), while the same investment made in 1976 would have grown to $2.27 million in 2006 (a 10.97 percent APR). The luck of when you are in the accumulation years of your life and what the market trends do during that period of time can have a dramatic impact on the final result and your income from investment during your retirement years.
Even a single year could make a difference, according to the Ibbotson study. $100,000 invested in the hypothetical portfolio in 1964 would have yielded $1.47 million in 1994 (9.37 percent APR) but investing the $100,000 in 1965 would have goosed the returns to $1.78 million (10.1 percent APR).
The lesson from this information, in my opinion, goes back to some of the time-tested advice. To deal with randomness (good or bad luck) in the financial markets, first acknowledge that when you do well, it is as much or more luck than skill. Don’t become so confident in your own abilities that you then subsequently assume too much risk and find out the hard way that like most people, you’re probably average as an investor, despite your very high level of skill at your chosen profession.
Next, embrace the uncertainty of the future. If you expect uncertainty, you won’t be disappointed, and you will probably make more level headed and disciplined investment decisions. Personally, this is where I spend most of my efforts as a professional investor, attempting to have our clients’ portfolios ready for the unforeseen and unpredictable events.
Last but not least, start investing early and have discipline. Despite the effects of randomness (luck), time still helps reduce the risk of the markets, and a disciplined approach to making investment decisions in conservative practical plan will probably provide the best results over time.
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. Visit www.breitercapital.com.