Beyond Buy-and-Hold #107
Last week?s column showed that there are circumstances in which a $100,000 portfolio offers the promise of delivering more lasting wealth than a $300,000 portfolio. It seems crazy. The trick is that this really is so if the $300,000 exists at a time of high valuations (when stocks always offer poor long-term returns) and the $100,000 exists at a time of low valuations (when stocks always offer outstanding long-term returns).
But even that rule has an exception. The graphic I advanced in last week?s column showed that, at the end of 30 years, the $300,000 portfolio almost caught up to the $100,000 one. Something that is true at five years may not be so at 10 years and something that is so at 10 years may not be so at 30 years.
Time: the stock market ?X? factor
There is almost nothing intelligent that can be said about stock investing without taking the factor of time into consideration. Unfortunately, most analysts ignore this factor. We ask analysts questions without specifying the time-period for which we want to know the answer and they provide responses that are on the mark for one a time-period and horribly wrong for another time period.
It?s a good practice to always stop and think when you hear a bit of investing wisdom whether that wisdom applies to all time-periods or only some. I?ve listed below three ways in which time can play a big role in the solution of an investing puzzle.
1. The Amount of Time That Your Retirement Plan Remains in Place Without a Price Crash Hitting It Determines Whether the Plan Will Survive 30 Years
I made my reputation on the internet showing that the Old School retirement studies got the numbers wildly wrong. The studies are in error because they fail to take into consideration the valuation level that applies on the starting date of the retirement and because this is the most important factor determining whether the retirement plan will work or not.
That said, not all retirements that begin at times of high valuations fail. In cases in which the retirees go with high stock allocations, those retirements are high-risk propositions, but there are cases in which poor bets pay off. The research tells us when the retirement plans of those who used unsafe withdrawal rates will survive all the same.
11 years. That?s the point at which an unsafe retirement plan can become safe.
Say that you retired in 1996 and used a 4 percent withdrawal (the withdrawal rate identified as ?safe? in the discredited studies). Stocks were insanely overpriced in 1996. So your retirement was by no mean safe. Under many returns sequences, your retirement would fail before you reached age 95. But, if we did not see a price crash until the end of 2006 (and we didn?t — the price crash came in late 2008), your retirement became safe despite your reliance on gravely flawed research.
The secret here is that those 11 years give the portfolio time to grow enough so that subsequent price crashes are not enough to destroy it entirely. Over time, the magic of compounding can grow such portfolios to very large amounts.
2. Valuations Don’t Matter Much After the Passage of 30 Years
For all the stress that I place on the need always to take valuations into consideration when making investing choices, I am here to tell you that valuations don?t matter much after the passage of 30 years. That?s what the research shows.
Why? Overvaluation and undervaluation are not random events. They show up as part of bull/bear cycles that generally last for time-periods of 35 years or so. Valuations go up and up and up until they get high enough to cause a crash and then they go down and down and down until they get low enough to cause a depression or a major recession. Then they start up again.
Stocks that you buy near the top of a cycle produce poor returns in 10-year and 20-year periods because at the end of 10 years and 20 years we are still working our way through the down cycle or at best are in the early days of our escape from it. But a 30-year time-period is long enough to include both the worst of the lows and the best of the highs. The two factors cancel each other out and the most likely return for a 30-year time period is thus something close to the long-term average return (6.5 percent real) regardless of the valuation level that applies at the time of the stock purchase.
3. The Value of Your Portfolio on Any One Given Day Is a Meaningless Number
People like to look at the number at the bottom of the last page of their portfolio statement to determine whether they are on track to meeting their investment goals. This is an exceedingly dangerous practice.
Many Buy-and-Holders tell me today that, even with the Lost Decade, they are not so bad off. And they point to the numbers on their portfolio statement as evidence. That proves it!
We are priced today for a 65 percent price drop sometime over the next few years. If the people trying to defend Buy-and-Hold divided the number on their portfolio statements by three, they would have a much better idea of where they stand.
That?s why my advocacy of Valuation-Informed Indexing makes many people angry. People do not want to divide by three. They want to place confidence in the unadjusted numbers. People view me as their enemy because I tell them that they are farther behind in their efforts to finance their old-age retirements than the Buy-And-Holders say.
My belief is that it is better to know the real numbers. The numbers on your portfolio statement today just don?t matter unless you are planning to spend all the money today. What you need to know is how much your portfolio will be worth five years from today and ten years from today and 20 years from today. To know that, you need to look at how stocks have performed throughout history starting from various valuation levels. The historical record (and the academic research based on it) tells us that today?s portfolio values cannot be trusted, regardless of how complacent they make us feel.