“Time, Time, Time is on my side… Yes it is.Time, Time, Time is on my side… Yes it is.”
– Mick Jagger
In last month’s article, we discussed how “Understanding Risk” is one of the great qualities to adopt for anyone who wants to become a great investor. This month we focus on a related, but slightly different quality…Great Investors Take Advantage of Time.
The Folly of Predictions
I recently read an exceptional essay written by legendary investor Howard Marks about the folly of making predictions, and how most “expert opinions” do nothing but make the “experts” look foolish.
One of the first things I learned as a wealth planning professional was to stay away from predictions. To become a great investor, one must have a healthy acceptance of the fact that investing is an exercise in managing uncertainty about the future, and is an “inexact” science at best. Great investors understand that there is a limit to the effectiveness of analyzing current information about the world, as a means to make future judgments about asset prices.
The quickest way to identify a wise, intelligent and skilled investor is to weed out the arrogant ones. Unfortunately, smart people know they are smart and often succumb to the character flaw of arrogance. But pride comes before the fall, and since you don’t want to fall, it is wise to be brilliant but humble. The simplest way to weed out the arrogant is to discount any expert who makes predictions. The world is way too complex for any individual to meaningfully grasp the future, the analytical power just isn’t possible in a single human brain.
Great investors also understand that there is also a direct correlation between time horizon and the predictability of investment markets. Specifically, the shorter the time horizon, the greater the unpredictability of market behavior.
Our “New Year Outlook”
I always get a good laugh in January every year when advisors, money managers, and other strategists publish their “outlook” for the markets for the coming year, as it seems to me that one year is far too unpredictable of a time period to project. Now that the first quarter of 2017 is over, it is safe to say that most of these “outlooks” for 2017, and how the “Trump Bump” would crash have already been proven wrong!
The fact is that markets are exceptionally unpredictable over short periods of time such as a year. Although the long term average annual return of the S&P 500 has been just about 10% per year since 1946, in any given year the dispersion of returns, as well as the intra-year movement can be dramatic.
For evidence of this fact, one of my favorite charts is reproduced below. The chart depicts the annual total return from the S&P 500 each year going back to 1979 (solid blue bar), but also shows the lowest point the market reached at any point in the year (red line), as well as the highest point the market reached during the year (Black line). It is clear that the annual dispersion of returns is all over the map, and that markets can be incredibly volatile on a short term basis. Consider the year 2009 – at one point the S&P 500 declined by close to 30% that year, but also had an advance of close to 80% that year, and finished the year up roughly 30%!
Our “30 Year Outlook”
As Mick Jagger famously noted, when it comes to stock market predictions…time is on our side. As we extend our time horizon the picture gets clearer, just like pulling back allows us to see the forest instead of the trees. Over the long term, the variability of annual investment results begins to narrow, and market returns begin to revert to the mean over a longer period. Our study of market behavior can begin to move from predictions about what will happen in the short term, to probabilities that future market behavior will resemble past performance over a long period of years. By taking a long term, probability based point of view, we can use time as a tool to help us become comfortable with our outlook for the future.
As we consider the long term historical behavior of asset classes, we can begin to draw some conclusions about the probability that those asset classes will behave in a similar way over the long term future. For example, the graph below plots the historical worst-case annualized returns for large-capitalization U.S. stocks and intermediate-term U.S. government bonds since 1926. Over shorter holding periods, bonds were less exposed to downside risks. Over one year, for instance, the worst case for bonds was a 5.1% drop, while stocks fell by 43.3% in their worst year. Over any historical three-year period, bonds provided a positive annualized return. It took 15 years before stocks historically were always able to provide a positive return. For holding periods of at least 17 years, the historical worst-case annualized performance for stocks exceeds that for bonds. Over 20-year periods, for instance, stocks experienced a worst-case 3.1% annualized return, compared to 1.6% for bonds. For 30-year periods, the worst-case for stocks was 8.5%, compared to 2.2% for bonds. And for 40-year periods, stocks’ worst performance was an 8.9% annualized return, compared to 2.8% for bonds. For historical 40-year periods, even the best case for bonds (8.1%) could not beat the worst case for stocks.
Another chart that makes the same point another way is our favorite bear market chart which is reproduced below, and which shows the actual short-term downside volatility that the stock market has produced in the past. As this table shows, since 1946 there have been 14 “Bear Markets” in stocks, which have caused stock prices to drop by anywhere from 19% to 57%, and which have lasted anywhere from 1.5 months to 3 years. However, despite all of those short term periods of volatility, the S&P 500 stands roughly 130 times higher today than it was in 1946.
This data doesn’t provide us with any information to accurately predict anything at all – the fact is that anything can happen in the future, even the long term future. However, it does help us to understand the probability that asset classes will behave in a certain way over the long term future.
The Great Goals of Life
We at Concentus believe that all successful investing is Goal Based and Planning Driven. An investment program only has use as a tool to achieve the goals of your financial plan. In our work with clients over many years, our clients have expressed the desire to achieve a wide variety of financial goals. However, we have noticed that the most important core goals of most of our clients revolve around 5 objectives that we call “The Great Goals of Life”:
- The endowment of a long, comfortable, and totally worry-free retirement, with no compromise in lifestyle, and no real concern about running out of money. A base of capital that continues to grow, even as you draw continuing income from it for three decades of an independent retirement.
- The desire to intervene meaningfully in the financial lives of one’s children, during your lifetime or in the form of a legacy
- The ability to fund the education of one’s grandchildren
- The capability to provide quality care for one’s parents in their later years.
- The ability to make a meaningful legacy to a much-loved school, church, charity or other institution.
Fortunately, this list of goals is generally long term in nature, and is likely to be achieved over a lifetime, or even multi-generational period of time. This list of goals allows us to place “Time on our side” as investors and wealth planners, because the really important financial objectives in most people’s lives are likely to unfold over many years – most people will live through 30 or more years of retirement, and their wealth transfer goals will live well beyond even that time frame.
The investor who truly understands the impact of time, and who accurately targets her investments to the proper time horizon, has a secret weapon that doesn’t rely upon market predictions or prognostications. Instead, she can simply play the probabilities and invest for the duration of her goals, using low volatility asset classes for those goals which have a short duration, and more volatile high growth asset classes for those goals which have a longer duration. And then sit back and wait.
Having a Plan
The very best investors have a disciplined approach to making portfolio decisions, and always stick to their plan, no matter what the rest of the world is doing. They always gear their investment program around the achievement of their most important life goals, and as a result are able to put “Time on their Side”.
No predictions, and no crystal balls. Just patience and discipline, and a healthy understanding of time.