The Misunderstanding Most Investors Make

The Misunderstanding Most Investors Make

I’ll be honest that I am not fully convinced as to what investment style works, and I am alright with that since my response is to have a little bit of everything. I have an actively managed dividend portfolio, a 401(k) made up mostly of actively managed mutual funds, a whole life insurance policy, and will eventually own a passive index account.   But I think there is a mistake that most investors make, this mistake can cost them thousands if not hundreds of thousands and possibly years of retirement.

The mistake that they make can be seen in a great exchange between Sam and a blogger I never really read before but has some good stuff, Jon from FreeMoneyWisdom on Sam’s post on whether Sam should sell everything this May since he has already made 10% in the market year to date.

Sell In May And Go Away

The mistake/misunderstanding is this idea that the market is guaranteed to make 8%/year, year in and year out.  The Market Does Not Guarantee Anything. I think Sam takes a sarcastic response to Jon that I am pretty sure went over his head lol.

Market Returns Vary

I will ignore the initial problem of where Jon pulls 8% out of considering that he is holding everything from “REITs to Large/small caps” and just focus on the return of the S&P500 since that is the often quoted number.  We will assume (a huge assumption) that the S&P returns between 8% and 10% per year.  Why is it a huge assumption?  because that number includes reinvested dividends, not selling when the market drops 37% like in 2007, you own just the S&P, etc. etc.

Info taken from a cool site that even lets you calculate different time frames, MoneyChimp.

2010     14.32
2009     27.11
2008    -37.22
2007      5.46
2006     15.74
2005      4.79
2004     10.82
2003     28.72
2002    -22.27
2001    -11.98
2000     -9.11
1999     21.11
1998     28.73
1997     33.67
1996     23.06
1995     38.02
1994      1.19
1993     10.17
1992      7.60
1991     30.95
1990     -3.42
1989     32.00
1988     16.64
1987      5.69
1986     19.06
1985     32.24
1984      5.96
1983     23.13
1982     21.22
1981     -5.33
1980     32.76
1979     18.69
1978      6.41
1977     -7.78
1976     24.20
1975     38.46
1974    -26.95
1973    -15.03
1972     19.15
1971     14.54
1970      3.60
1969     -8.63
1968     11.03
1967     24.45
1966    -10.36
1965     12.45
1964     16.59
1963     23.04
1962     -9.20
1961     28.51
1960     -0.74
1959     11.59
1958     43.40
1957     -9.30
1956      6.38
1955     28.22
1954     55.99
1953     -0.80
1952     18.35
1951     23.10
1950     34.28
1949     15.96
1948      9.51
1947      2.56
1946    -12.05
1945     39.35
1944     19.67
1943     23.60
1942     21.74
1941     -9.09
1940     -8.91
1939      2.98
1938     17.50
1937    -32.11
1936     32.55
1935     54.93
1934     -8.01
1933     56.79
1932     -5.81
1931    -44.20
1930    -22.72
1929     -9.46
1928     47.57
1927     37.10
1926     11.51
1925     25.83
1924     27.10
1923      5.45
1922     29.07
1921     10.15
1920    -13.95
1919     19.67
1918     18.21
1917    -18.62
1916      8.12
1915     31.20
1914     -5.39
1913     -4.73
1912      7.18
1911      3.52
1910     -3.39
1909     16.15
1908     39.47
1907    -24.21
1906      0.64
1905     21.29
1904     32.16
1903    -17.09
1902      8.28
1901     19.45
1900     20.84
1899      3.66
1898     29.32
1897     20.37
1896      3.25
1895      5.01
1894      3.63
1893    -18.79
1892      6.14
1891     18.88
1890     -6.16
1889      7.09
1888      3.34
1887     -0.64
1886     11.98
1885     30.06
1884    -12.32
1883     -5.49
1882      3.61
1881      0.27
1880     26.63
1879     49.37
1878     16.29
1877     -1.06
1876    -14.15
1875      5.44
1874      4.72
1873     -2.49
1872     11.16
1871     15.64

You have to go all the way back to 1902 to find an 8% positive return in the S&P and 10% only happened a few times in the 100+ history of the S&P.  So please don’t just assume because you invest in a diversified portfolio, or even a passive index fund on Jan 1 that on Dec 31 you’ll have 8% more money.

12 Responses to The Misunderstanding Most Investors Make

  1. I can’t speak for Jon, but I think what he meant was annualized returns. From 1990 (randomly picked up a year!) to 2010 S&P grew at the rate of 8.5% annualized.

    • Correct but if you threw money into the investment from 98 till 2002 and tried to retire in 2002 you’d be dead in the water (with an average return of 1%).

      I get that the longer you are in the market the better, but imagine if you missed 2008? Just got out because you got out in 2007 up 15%?

      • I think index fund are great if you keep dollar cost averaging into it over 15-20 years. Once the contribution become insignificant in relation to the total value of the portfolio, then it’s time to change strategy a bit.

  2. I agree with Jon (Free Money Wisdom), but for different reasons. The market over time has a return of 8-10%. The issue is how long is the time? I believe it is 35-40 years. In any particular year or sometimes a number of years the market will be above and below that average. Since I am a very bad market timer, I stick with my asset allocation and dollar cost average into the market. I look at my portfolio annually to re-balance. I am pleased with my results, but I may have completely different objectives and goals. Some people invest for immediate income, growth, capital preservation, and a combination of any of these goals. Investment philosophy is personal for your needs.

    • Not sure if it is an agree or disagree thing. Jon was correct, but I think that a lot of investors forget that it might actually take 10 or 20 years before you see 8% rather than just 1 or 2

  3. I was up 11% when I sold Evan. Come on now, 100bps makes a difference!

    Again, I’ve never heard of anybody lose money in the markets. We are all rich!

    At least my post has a time stamp and a 1,370 SP500 and 12,850 Dow mark. I definitely do plan to re asset allocate, I just am happy to take profits.

    Finally, I suck at picking stocks. I just know what returns I’m comfortable with.

    Thx

  4. You definitely have a great point. I always hate it when ppl say “Assume I get a 5% return annually…” That’s a HUGE assumption over sumthing you have little to no control over

  5. All depends on when we start and finish, doesn’t it? I have a friend who on the cusp of retirement, sold everything and shifted into cash and bonds… in late 2007. Nice timing.

    • I always cringe when I talk to older individuals who are on the cusp of retirement and they are sticking with 90% equities…

  6. No simple view of the markets is accurate. Trying to time them proves to be a bad practice for most all investors. Playing that game a bit around the edges can make sense. But you can be burned quite a bit.

  7. Hmm, I took it a different way. The anonymity of the internet gives way to people who lie about pretty much everything. Active investing is a lot like telling fishing stories…

    At any rate, I’m no Boglehead, and don’t plan to be one any time soon. Passive investing, in my view, limits the advantage that the small investor has in illiquid markets. Small investors have plenty of advantages, but everyone tells them they don’t, so they falsely believe it to be true.

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