"...YOU MAY NOT HAVE ENOUGH TIME TO WAIT OUT SOME OF THE DOWNS THAT CAN HAPPEN IN THE MARKET."
1.S&P 500 History: http://www.investopedia.com/ask/answers/041015/what-history-sp-500.asp
2.Dow Jones During Great Depression: http://content.time.com/time/nation/article/0,8599,1854569,00.html
4.Nikkei 225 Data: https://finance.yahoo.com/quote/%5EN225/history?p=^N225
Hey again, I’m Mike Frontera and here’s today’s retirement insights. You’ve probably heard of the investment philosophy of “buy and Hold”. Buy and hold simply being the strategy of buying certain investments and for the most part, just hanging onto it. Letting it ride and sitting through the ups and downs of the market. The theory being that over a long period you will be rewarded for your time in the market.
And while this strategy does have some merit, there are several critical flaws associated with it. And one of those flaws I’ll talk about today is the “hold” part of the buy and hold strategy. More specifically, the amount of time you have to hold what you’ve purchased.
Average investors will often bring up buy and hold strategies when buying a mutual fund that tracks a stock market index
like the S&P 500. Buy and hold strategies can look very good on paper when you look back over decades and decades of market data. I hear very often, that the S&P 500 has average over 9% annual returns per year since its inception in 1957.
But in the real world, we don’t necessarily have that much time to wait out the ups and downs.
Let’s think of an investor in 1929. Had an investor been able to invest in the Dow Jones Industrial average and been unlucky enough to plunk down his savings at the peak of the market on September 3rd2 of that year – he would have had to wait over 25 years to get back to his starting value. But forget the Great Depression, that was almost 90 years ago. Let’s look at a more recent period.
Now look at the S&P 500
in 1965. It closed in November of that year at a high point of 92.65. During the sideways market that followed throughout the rest of the 60’s and 70’s it crossed that same point again and again, finally surpassing 92 for good in 1979. Had a 40-year-old investor been able to invest in that index, they would have watched their account rise and fall only to still be at the same place again at age 54. Do you think it can’t happen like that again?
Let’s look at S&P 500 right at the turn of the century. The index hit 1527 in March of 2000. Now let’s picture again, a 40 year old investor with a buy and hold strategy that was able to buy the index at that point.
They would have seen their account value drop almost in half over the course of the next two and a half years when the S&P 500 closed at 777.76 in October of 2002. Had they pressed on using their “stocks always bounce back” motto, they would have seen their account claw its way back to a new high about 7 ½ years later to 1565 in October of 2007. So 7 ½ years in, at age 47 they’d be back to square one. And then the big one hits. They have to once again hang on tight as the index drops to 676 by the time March of 2009 comes around. They’re now almost exactly 9 years in and the price of their index is worth less than half of what it was 9 years ago. They’re now 49 years old.
But they hang in there and take the slow ride back up to watch the S&P 500 finally surpass the mark it hit in 2000 for the last time (so far) on February 19th of 2013. Our imaginary investor is now 53 years old.
Remember this assumes that our investor has the discipline to watch his savings get basically cut in half twice as he gets closer and closer to retirement and still decide to not make any changes.
While you cannot invest directly S&P 500 index, there are many exchange traded funds and mutual funds out there that attempt to follow it. And please don’t get me wrong. I am not saying you should never allocate any money to one of these funds. Not by any stretch. In fact, I’m not making an investment recommendation of any kind.
What I’m saying though, is that when you adopt a “buy and hold” strategy you need to know that your human, life-based goals have a limited holding period. And that during a market downturn, you can only push out that holding period so far before you start to radically alter what your goal is.
I know that after seeing all this a some of you may say “yeah, but look what happened right after those periods you’re showing”. That’s where the stock market really took off. So if I have more time, I should be ok. Well, that might be true… so let me provide you with one more example.
Japan’s most popular stock market index is the Nikkei 225. So let’s once again pretend. Let’s pretend once more that you’re an investor, this time in Japan, this time a young 30 year old investor and you’re able to invest
all of your retirement savings in the Nikkei 225. Your stock market has been doing well and your economy has been doing well for decades. It’s December 29th of 1989 and the Nikkei 225 has just closed at 38,916.
You put your money in ready to ride it out for better or for worse. Had you made that decision, you would still be waiting for your investment to come back to where it was. In fact, you wouldn’t even be close yet. As of December 29th of 2016, which is exactly 27 years later, the Nikkei closed at 19,145.14. Which is just less than half of where it was 27 years ago. Meanwhile, you would have aged from 30 years old to 57 years old.
Now in fairness, we’re talking about a different country with a different stock market index. The question is though—do you feel that we are so far removed from Japan as a country, that we are so much different, that we’d be immune to something like that?
The point of all of this is you need to be very careful not just of what you buy but also how long of a hold you have. You may not have enough time to wait out some of the downs that can happen in the market.
You must first have a handle on not just what your goals are, but when those goals are to be reached. Your portfolio should not take on so much risk that a market downturn risks pushing you beyond the timeframe of your goal. In other words, if you have five years left to reach your goal, it probably would not be a good idea to
build your portfolio with all higher risk investments that may likely take more than 5 years to recover from a market downturn.
Of course, you would be wise too, to properly diversify your holdings. Effective diversification can help, should one of your investments experience the prolonged downturn that say like the Nikkei has experienced. In an otherwise well-diversified portfolio, an experience like that should not have a catastrophic effect on your goal.
Also, keep in mind that the time-frame to your goals generally gets shorter as time goes on. Your portfolio’s overall allocation of investments should evolve to reflect that. That means the allocation you have today may very well be different than the one you have three years from now.
Finally, know that some goals, like saving for retirement, are more complex and
generally should be treated as having more than one time-frame. After all, if you retire today, you need money now- but you also need money in five years, 10 years, 18 years, 26 years, and so on. This is truly where having a financial professional by your side to manage the structure of your portfolio during this very complex and exceedingly important goal is so valuable.
Thank you again for joining me, I’m Mike Frontera -and by the way, like me on Facebook to see my updated videos as I publish them.