China devalued its currency!
Greece is doing a Walenda on a tightrope above a flaming chasm of financial ruin!
Puerto Rican debt is in the toilet!
The Dow plummets hundreds of points!
The chatter in the lunchrooms, locker rooms and Boardrooms is aimed at piecing together the meaning and ramifications of such global money events.
Meanwhile, oil prices plummet. Bananas are dying of a worldwide fungus epidemic. California is still dry. And the Dow soars hundreds of points.
If you’re like many people, these situations make you nervous and unsure of what to do. With short-term interest rates at near zero and long-term bonds paying paltry returns (with the promise that their values will collapse at the first Fed tightening), there doesn’t seem to be a safe haven anywhere. What to do? What to do?
Let’s start by considering history, your expectations and what factors drive your thinking and actions.
History: It’s no secret that there are recessions, expansions, stable periods and even global depression in our history. It happens. Business cycles, changes in technology, shifts in population, famine, war, scandals and new discoveries all add to the goulash of results that occur in world markets. Somehow, businesses emerge, businesses fail, companies prosper, shareholders participate in the failure and success. There is no straight-line or any predictive factors that can assist investors in always making wise choices. There are simply too many variables.
Your expectations: Intrinsic to your expectations comes your ability to take on risk. In other words, if history is a good teacher, we expect a given level of return for a given level of risk.
If you expect greater return without the risk, your expectations are probably skewed toward the blatantly unreasonable. Every investor expects to win—otherwise, they wouldn’t enter the “game.” The real question is whether your expectation is realistic within the given time frame and the given level of risk.
For example, if your goal is to earn a 5% rate of return over the next five years and you are only willing to put your money in money markets and short-term treasury bills, your chance of success is pretty low considering the current state of interest rates. However, according to the Federal Reserve database (FRED), if you had been invested in those three month T-Bills from 1965-2014, your arithmetic average would have been 5.04% (geometric average 4.99%), but between 2005-2014 your return would have averaged 1.44% (geometric average 1.42%).
Another example. If you wished to grow your money at better than 5% over a long period of time, the S&P 500 would have yielded 11.23% (arithmetic), and 9.84% (geometric) between 1965-2014 and 9.37% (arithmetic) and 7.60% (geometric) between 2005-2014. But that would have meant accepting negative returns in 1973 and 1974 of -14.31% and -25.9%, and years like 2000-2002 of consecutive negative returns of -9.03%, -11.85& and -21.97% and of course 2008 with the stunner loss of -36.55%. Along with those down years come the days, weeks, months and years of negative news, terrible forecasts and predictions of world financial cataclysm.
Factors driving your thinking and actions: The behavioral finance experts tell us a great deal of our decisions come from our expectations and our beliefs. We believe that we are smart and rational. And in many ways, we are—just not when it comes to making wise investment decisions. The Dalbar QAIB (Quantitative Analysis of Investor Behavior) study showing investor results vs. the market is stunningly telling. In 2014, the 20-year annualized S&P return was 9.85%, while the average equity mutual fund investor was only ahead 5.19%, a gap of 4.66%.
Let that sink in a little.
Yes, if you watch the news, read the paper, surf the net or listen to the conversations all around you, the world is crumbling and there’s no hope. But then again, it’s always been that way—we just know about it in real time now. The fact is, no one can predict the future, but we can learn from the past. Over-reaction most often causes unintended and unwelcome results. Do you know anyone who cashed out during the peak of the last Recession? Was it you?
Maybe it’s time to tune out for awhile and see if anything—other than your worry—changes.
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