Fidelity Investments recently published “Don’t Let Fear Disrupt Your Investing” which discusses the idea of not making emotional decisions during market turmoil which can lead to poor investment decisions.
While the premise is sound, the article is riddled with problems of data mining, as well as the same tired investment advice that has led to demise of many an investor over the last decade.
Unfortunately, several major publications such as Reuters, MarketWatch, US News & World Report, and others picked up the article and distributed it as well without taking the time to fully comprehend the problems with the article.
“Some investors, including both individuals and professionals alike, have been prone to altering well-thought-out investment plans during such periods of heightened financial market turmoil. Decisions to move in and out of an asset class tend to be made hastily and out of fear and anxiety due to innate behavioral biases, as opposed to a disciplined portfolio review that considers how various assets should be allocated to suit one’s investment objectives, risk tolerance, and time horizon.”
The opening paragraph of the article is absolutely true and is something that we have discussed in many of our previous missives and blogs. Emotions and investment decisions are very poor bedfellows. Unfortunately, the majority of investors make emotional decisions because, in reality, very FEW investors actually have a well-thought-out investment plan. Retail investors generally buy an off-the-shelf portfolio allocation model that is heavily weighted in equities under the illusion that over a long enough period of time they will somehow make money.
However, when they fail at the “beat the S&P 500 index” contest from one year to the next they are swayed to find another financial advisor. Why? Because they didn’t have a well-thought-out investment strategy to begin with and the lack of a solid investment foundation leads to emotional decision making and performance chasing. Wall Street firms feed on this weakness as “money in motion” on Wall Street creates fees for Wall Street and not necessarily better performance for you. Furthermore, this consistent changing of strategy generally leads to chasing last year’s hottest performing fund or manager which keeps investors jumping from the “frying pan into the fire.”
Fidelity goes on to give the classic argument; “Despite many troublesome events, the stock market has been resilient over time. Given their longer-term horizons, retirement investors would seem to have the greatest motivation to resist short-term pressures and stick to a predetermined portfolio allocation amid event-driven market volatility. A recent Fidelity report on the investment behavior of participants in workplace retirement savings plans shows that most people did stay on track during the peak 2008–09 period of financial market instability. However, it also showed that there were costly implications for the fraction of people who did tinker with their portfolios based on the market turmoil.“
Exactly how long does Fidelity expect retirement investors to live? Let’s consider the following facts in regards to the average American. The national average wage index for 2009 is 40,711.61. That index is 1.51% lower than the index for 2008.
- 56% of the average workers in America today have less than one years salary saved with less than $25,000.
- 76% have less than $100,000; and
- 90% have less than $250,000 saved.
If we assume that the average retired couple will need $40,000 a year in income to live through their “golden years” they will need roughly $1 million dollars generating 4% a year in income. Therefore, 90% of American workers today have a problem.
However, what about those already retired? Given the boom years of the 80’s and 90’s that group of baby boomers should be better off, right? Not really.
- 54% have less than $25,000 in retirement savings
- 71% have less than $100,000; and
- 83% have less than $250,000.
Now you understand why baby boomers are so reluctant to take cuts to their welfare programs. The average American faces a real dilemma heading into retirement. Unfortunately, individuals only have a finite investing time horizon until they retire. Therefore, as opposed to studies discussing “long term investing” without defining what the “long term” actually is – time is the single most precious commodity.
When I give lectures and seminars I always take the same poll – “How long do you have until retirement?” The results are always the same in that the majority of attendee’s have about 15 years until retirement. This is because most investors don’t start seriously saving for retirement until they are in their mid-40’s. If we assume that most investors work until the age of 65 that gives the average investor 15-20 years to save for retirement.
Here is the problem. To prove their point about the success of long term investing Fidelity drags out the long term, logarithmic, chart of the S&P 500 index. At first glance the average investor will agree with Fidelity. However, the chart is VERY misleading as it only looks at data from 1963 onward and there are several problems that the naked eye, at first glance, will not catch:
1) If you started investing in 1963 at the end of 1974 you actually had less money than you started with and by 1982, on an inflation adjusted basis you actually faced a negative return. (19 Years)
2) From 1982 to 2000 the market rose during one of the greatest bull markets in history due to the collision of variables that occurred all at once. Falling high interest rates and inflation supported a period of unprecedented multiple (valuation) expansion. (18 years)
3) From 2000 to Present – the unwinding of the stock market bubble, excess credit and speculation has led to negative returns, both a nominal and real, for investors. (11 years and counting).
So, assuming you started investing in 1963, today, 48 years later, you made money during one 18 year span out of 48 years in total or roughly 37.5% of the time. Those aren’t very good odds and the reality is that very few people have 48 years to retirement.
However, this pattern doesn’t exist from just the 60’s. These cycles exist all the way back to beginning of the financial markets in the U.S.
The chart shows the secular (long term) cycles of the market over history. Here is the critical point. The MAJORITY of the returns from investing came in just 4 of the 9 major market cycles since 1882. Every other period yielded a return that actually lost out to inflation during that time frame.
- The average BEAR market cycle lasted 15.6 years if we include the 11 years of the current cycle.
- The average BULL market cycle lasted 10.75 years.
The critical factor here was being lucky enough to be invested during the correct cycle. With this in mind this is where Fidelity’s article goes awry with selective data mining:
“Among the key findings: On average, participants who kept contributing to their retirement plans throughout the 18-month period (October 2008–March 2010) had higher account balances than those who stopped contributing; Participants who maintained a portion of their retirement plan asset in equities throughout the entire period ended up with higher account balances than those who reduced their equity exposure amid the peak period of market distress.
Thus, retirement investors who kept contributing to their plan and who maintained some exposure to equities throughout the period were better off throughout the market’s 18-month bust-boom period than those who moved in and out of the market in an attempt to avoid losses. Retirement investors who kept exposure to equities amid the peak of the global financial crisis ended up with higher account balances on average than those who reduced their equity exposure to 0%.”
The main problem here is selection of the start and ending period – October, 2008 through March, 2010. As you can see in the chart the PEAK of the financial market occurred a full year earlier in October, 2007. Fidelity picked a point assuming the most panic by investors – however, the problem is that puts you a full 3/4ths of the way through the financial crisis. In other words, if you weren’t out of the market by October 2008 it was already too late.
Fidelity stated that; “Retirement investors who kept exposure to equities amid the peak of the global financial crisis ended up with higher account balances (21% according to their research) on average than those who reduced their equity exposure to 0%.” However, using Fidelity’s analysis, and some math, here is what the portfolio destruction actually looks like:
Assuming that an investor had $1000 invested at the peak of the market in October of 2007 and remained allocated as Fidelity suggests through the correction of the market until March of 2010 – their portfolio would be worth $835. As of last Friday (08/19/11) it would have been worth $732, or a loss of 26.71% for the period.
Fidelity is correct in this one aspect. Had an investor bailed out in October (red dotted line) their portfolio would have been 45% higher in March of 2010 and only 27% higher as of last Friday. The problem is that they are still down in their portfolio. Could investors have done something different?
That answer is yes. By utilizing a very simple moving average cross over system, as an example, an investor could have negotiated the market turmoil with portfolio returns that would look vastly different. As illustrated in the chart above, with only 5 movements in portfolios since the peak of the market, the investor would have managed a POSITIVE portfolio return of 24.4%. (This is capital appreciation only not assuming dividends)
(Note: This assumes that the investor moves 100% to cash from the S&P 500, and vice versa. We do not recommend this. At Streettalk Advisors we maintain an allocation to equities at all time, however, we may reduce that allocation to very low levels or add short positions to hedge portfolios during market declines. Absolute timing of the market is extremely difficult in reality. The above is purely hypothetical example and does not reflect any actual portfolio model or performance. This is for illustrative purposes only.)
Here is the question that needs to be answered? Every successful investor in history from Benjamin Graham to Warren Buffett have very specific investing rules that they follow and do not break. Yet Wall Street in general tells investors that they can NOT successfully manage their own money and that “buy and hold” investing for long term is the only solution. Why is that?
As we stated previously, Fidelity is correct about the overriding premise regarding loss aversion. Investors do consistently make “emotional” decisions in their portfolios which is why they tend to “buy high” and “sell low”. This is really due to nothing more than the lack of a well-planned and executed investment and saving strategy.
There is a huge market for “get rich quick” investment schemes and programs as individuals keep hoping to find the secret trick to amassing riches from the market. There isn’t one. Investors continue to plow hard earned savings into a market hoping to get a repeat shot at the late 90’s investment boom driven by a set of variables that will most likely not exist again in our lifetimes.
The problem for most investors is that they have been led believe that investing in the financial markets is their only option for retiring. Unfortunately, they have fallen into the same trap as most pension funds which is that market performance will make up for a “savings” shortfall. However, the real world damage that market declines inflict on investors, and pension funds, hoping to garner annualized 8% returns to make up for the lack of savings is all too real and virtually impossible to recover from. When investors lose money in the market it is possible to regain the lost principal given enough time, however, what can never be recovered is the lost “time” between today and retirement. “Time” is extremely finite and the most precious commodity that investors have.
So, why does Wall Street continue to preach “buy and hold” investing and “dollar cost averaging” in a secular bear market cycle. The answer is simple – profits. The media, which receives revenue from Wall Street in the form of advertising, and Wall Street, which receives revenue from individual investors, are benefited by being inherently optimistic. For Wall Street, and Fidelity, their primary agenda is the selling of product and services to its clients. There is absolutely nothing wrong with this – it is just important that you understand their motives behind their “research”. They benefit by keeping your money invested in their products at all times in order to collect a fee for those invested dollars. This is why their research is always slanted at that angle.
Think about “Buy and Hold” and “Dollar Cost Averaging” from THEIR point of view.
Let’s assume that Fidelity has roughly $400 Billion under management that they charge, on average, 1% in fees for the mutual funds that people are invested in. (This is hypothetical and just for the purpose of illustrating a point.)
Let’s also assume that they have roughly 4 Million accounts and that every account contributes just $1,000 a year into in the form of dollar cost averaging.
Here are the numbers:
$400 Billion at 1% annually is: $4 Billion Annually In Revenue
4 Million Accounts x $1,000 in contributions is: $4 Billion in annual NEW assets.
$4 Billion x 1% annually is: $40 Million Annually in Additional Revenue
As you can see this isn’t chump change which is why that from a marketing standpoint picking October 2008, when looking in hindsight, is obviously “data mining” to obtain a specific result – keeping you invested.
Fidelity is a very lucrative business model and most people follow their advice because, emotionally, they are looking for someone that they believe knows more about investing than themselves. They desperately want to believe that someone is there that they can entrust their savings to, a company they deem credible and, hopefully, a company that will look out for their best interest.
However, with client’s, once again, facing considerable losses in investment portfolios; clients are beginning to not only leave the equity markets and go to cash (which is not profitable for Fidelity’s mutual funds) but leave Fidelity altogether for other options like CD’s and active portfolio managers that manage investment risk.
That isn’t good business for Fidelity and in a time where corporate profits are under pressure, trading fees are down and pressure to perform is high. So, an attempt to calm clients and restrain them from jumping the ship is critically important. It isn’t just Fidelity either. Lately every major mutual fund company has been hitting the press with a barrage of marketing pieces to calm investors and assure them that the future will “surely” get better and soon.
With the economy on a brink of second recession, without further injections from the Fed to boost asset prices, stocks are poised to go lower. During an average recessionary bout stocks lose on average 33% of their value. With the markets down only 18% from the peak earlier this year any further decline will set investors back two or more years on their retirement savings goal. This leads to the real question which is whether or not your personal investment time horizon is long enough to endure the remaining 5 years or so left in this current secular bear market (assuming this is just an “average” secular bear market).
In the end – yes, emotional decision making is very bad for your portfolio in the long run. However, before sticking your head in the sand and ignoring market risk on an article that touts “long term” investing always wins is not a “well thought out investment strategy” either. It is critically important that before you follow any investment strategy, or advice, that you analyze the data first and ask yourself who’s bottom line is it really benefiting. This is your money – if you don’t pay attention to it no one else with either.