Every Stock Investor Experiences One 20-Year Period of Poor Returns

Beyond Buy-and-Hold #56

The Stock-Selling Industry doesn?t like us to time the market. Why? They only make money when we buy stocks. If we become unwilling to buy stocks at times when stocks offer a poor long-term value proposition, there will be times when those in the industry will be making less money than they would be making if we would all agree to forsake market timing.

Many investors don?t see this as being such a big deal. They hear lots of stock-selling experts telling them that it is not necessary to time the market and they go along. Even if the experts are shading the truth a wee bit, it cannot hurt them all that much to go along, can it?

It can hurt an awful lot

In fact, it is certain to hurt an awful lot. I?ll explain why using figures taken from the Yale Economics Professor Robert Shiller?s book Irrational Exuberance.

It is possible for non-timers to do just fine with their investments for five years or ten years or even fifteen years. That happens often. In fact, if you check the historical record, you will see that it is the norm.

The trouble is — Most of us are investing to finance our old-age retirements. To finance a comfortable middle-class retirement, you need to accumulate $1 million in capital or more. Unless you are a Cy Young Award winner, you are not going to be able to pull that off in five years or ten years or fifteen years. It?s going to take longer. That?s why non-timing stock investment strategies always fail.

Say that you begin investing at age 25 and that you hope to accumulate the $1 million or more by age 65. That means that you must avoid a financial wipeout for 40 years running. There has never in U.S. history been a time when a non-timing strategy (that is, a Buy-and-Hold strategy) has not suffered a wipeout at some point in a 40-year time period.

The only thing that stops markets from careening out of control and causing economic crises is the willingness of most stock investors to sell when prices get so high that stocks no longer offer a strong long-term value proposition. Buy-and-Hold teaches investors that there is no need to sell regardless of how high prices go. This strategy takes the brakes off the stock investing car.

Why controls?and skepticism?really do matter

Cars without brakes always crash. The crashes experienced by Buy-and-Holders (non-timers) wipe out large portions of their accumulated capital of a lifetime. Most investors who follow non-timing strategies lose so much wealth as a result of doing so that they are never able to recover.

Let?s look at the historical record to see how the realities of stock investing play out over an investing lifetime.

Shiller reports that there have been four times in U.S. history (from 1870 forward — that?s as far back as we have records) when stocks became insanely overpriced and brought on a crash and an economic crisis. The price drops began in: (1)1901; (2)1929; (3)1966; and (4)2000. We of course don?t know yet how things will turn out in the post-2000 period. But we have records showing what type of hit was delivered to investors who failed to time the market in the years leading up to the 1901, 1929 and 1966 market tops.

The average real return (including dividends) in the 20-year time-period beginning in 1901 was a negative 0.2 percent per year. The average real return (including dividends) in the 20-year time-period beginning in 1929 was 0.4 percent per year. The average real return (including dividends) in the 20-year time-period beginning in 1966 was 1.9 percent per year.

You have 40 years available to you to finance your retirement. To experience negative returns or very low positive returns for 20 of those 40 years makes it all but impossible for you to achieve your retirement goals.

But there is no one in the 140 years for which we have records who followed a no-timing strategy for 40 years who avoided all four of these time periods. If you started investing in 1870, your number was up in 1901. If you started investing in 1920, when the first bad 20-year time-period came to an end, your number was up in 1929. If you started investing in 1949, when the second poor 20-year time -period came to an end, your number was up in 1966. If you started investing in 1986, when the third poor 20-year time-period came to an end, your number ws up in 2000.

There is no escape

I need to add a wrinkle.

If you knew that these poor 20-year time-periods were coming up, you could have done okay. If you knew that you would not be seeing significant gains for 20 years, you could rein in spending enough to have your retirement plan work out despite the 20 years of poor returns.

But what non-timer would do such a thing?

Buy-and-Holders count the temporary gains they receive during out-of-control bull markets as real money. Naturally, they give themselves permission to spend more when they see those big numbers on their portfolio statements. When the Pretend Money disappears, they are left busted.

The thing to do is to lower your stock allocation when we reach the valuation levels that bring on those 20-year time-periods of negative or super-low positive returns. The thing you want to watch for is the P/E10 level. When it goes above 25, we are heading into years and years and years of poor returns. For heaven?s sake, time the market in those circumstances!

The P/E10 level hit 44 in January 2000 (far above the previous high of 33, the P/E10 level that brought on the Great Depression). Not good.

The title for Rob Bennett?s review of the book Work Less, Live More is ?The Retire Early Movement Grows Up?. Rob?s bio is here.

( Photo from Flickr by Helico )

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