At times during the last two weeks, it’s seemed that the investment world has been spinning on its head. It can make you feel like everything has changed. But has it?
First of all, did your goals change in the last two weeks? Possibly, but probably not. No matter what happens in the stock market day to day, most investors still look for variations of tried and true goals:
- Real return after inflation
- X dollars when I wake up on my 65th birthday
- The opportunity to retire on the schedule of my choice
- Diversification to get me through the investment unknowns of the future
- A stable pool of capital
- Ways to win the battle against inflation, investment expenses, and taxes
- The ability to pass some degree of wealth on to future generations
Do the tools still work?
While uncertainty is normal in turbulent times, I expect most people have the same long range plans today as a month ago. If your goals haven’t changed, the next question is whether you should change the tools you’re using to pursue those goals.
Has the crazy volatility in recent days changed the fundamental roles of stocks, bonds and other investments? In my opinion, it has not. We know and expect stocks to be more volatile than bonds and money markets, and for that additional risk that stocks carry, we expect a higher long-term total return.
On a daily, monthly or yearly basis, the return of stocks can and do jump all over, but over the last 40 years, the annualized total return has converged in the 10-12% range.
The chart below shows the total annualized return on a hypothetical investment made in the Dow Jones Industrial Average in late July 1971. (No Dow index fund existed at the time, of course.) Over the period 1971 to 1986 (not shown), the investment provided an annualized return of just over 10 percent. Since 1986 the annualized return has risen and fallen in a fairly narrow range to land at its current level of approximately 10.25 percent.
(Click image to enlarge)
Keep in mind all that has happened since 1986 – Black Monday, the dot.com bubble, 9/11, the horrors of the financial crisis, and much more. Through it all, the long term total annualized return (which includes the persistent reinvestment of dividends as discussed in recent posts) has held up well. Even the rollercoaster of the last few weeks appears as just a tiny dip at the end of the time series.
We keep driving
For some reason, car metaphors often work in investing. Let’s say you are driving from Boston to the Berkshires. After 40 miles traffic comes to a halt. An accident ahead. You crawl along for an hour and finally reach the accident site, a horrible scene of debris, stranded travelers, and emergency vehicles.
The accident shakes you up and reminds you of the dangers of highway travel. But your goal destination has not changed, and even with the time you’ve lost you continue your trip. And you keep your car. You know that there are risks in driving, but also know that automobiles, properly maintained and driven with care, have a good track record of delivering people safely to their destinations. Even with real and severe risks, the auto remains an effective tool for transportation and is often the clear best choice in getting from A to B.
Unsettling accidents notwithstanding, we keep driving.
Does it matter?
I know many investors abandoned stocks in the last couple weeks. The quick decline in prices made that clear; many wanted out. I understand how that can happen, but I encourage investors to stay focused on their goals and ask, “Aside from my discomfort, does this volatility really make a difference?” I feel it does not.
At Osbon Capital Management, we practice goal-based investing, where the focus on reaching client goals never wavers, no matter what happens to stock prices on a daily basis.
Also this week, some interesting reading: A New York Times article, “All the Ways that Stocks Churn Your Stomach.”
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Returns are based on data from July 25, 1971 to August 8, 2011. Total return includes price appreciation and dividend yield. Returns assume reinvestment of all dividends.
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