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How the Indy 500 is Like Your Investments

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The stock market has experienced a nice rise upward since its March 2009 lows.  So far this year, through April 30th, the S&P 500 has returned 1.92%.  Real estate as an asset class has been down with the DJ US Select REIT TR index posting a return of -1.35%.  International (MSCI EAFE NR USD) is the top performing asset class though the end of April with a 9.16% return.  (Souce: Morningstar as of 4-30-2015)

Many successful long-term investors don't get too excited when things are going well, and they don't despair when things are going poorly. Instead, they stick to long-term plans that are built around their financial goals and their tolerance for risk.  We believe that the best way to reach those long term goals is to remain disciplined and patient – whether you are experiencing joy over the markets recent good returns or grief from periods when things aren't so great.

Study after study has shown the importance of staying disciplined. Case in point: A recent report by research firm Dalbar, Inc. The study found that between January 1, 1985 and December 31, 2014, the stocks in the S&P 500 index returned an average of 11.06% annually. Yet the average stock investor only gained 3.79% on average over the same period.  One major reason for this sort of performance gap is that most investors just don't stick to a plan. They fall prey to their emotions and try to "time" the market—jumping in and out as stocks rise and fall. The result is usually all too predictable.

Here is how the Indianapolis 500 is like your investments. Last year Ryan Hunter-Reay won the 500 with an average speed of 186.563 mph.  The fastest race lap was from Juan Pablo Montoya at 225.191 mph. When you look at just the 186.563 mph as Ryan Hunter-Reay's average speed, it doesn't give you any indication that these cars are turning laps at 220 mph plus.  So if the cars can go 220 mph, why can they not average more than 186.563 mph during a 500 mile race?

Many laps of the 500 have high average speeds but then a yellow flag can come out because of an accident and the cars have to slow down behind the pace car.  Consider that the average speed for caution laps is 75-80 mph, sometimes as high as 120 mph.  Either way, significantly slower than racing speeds.  There were five cautions during the race for a total of 21 laps.  Many times during a caution drivers will go into the pits to change tires and refuel.  The speed limit on pit lane is 60 mph so pit stops also greatly reduce their average speed.

Investments perform in similar fashion.  Looking at the chart below you'll see that the return of the U.S. stock market from 1926 through 2014 has averaged 10.24% per year.  This is like Ryan Hunter-Reay's average race speed of 186.563 mph.  Over those 89 years the market had an annual return within two percentage points of the average of 10.24% only 6 out of 89 years.  That's like saying that Hunter-Reay turned lap speeds near 186 mph only 13 out of 200 laps.  Some years the market did really well, like 2009 when it was up 26.26%.  And some laps Indy cars go really fast, like Montoya's 225 mph lap.  Other times the market is way down such as in 2008 when it was down 37%.  Similarly race speeds are way down on yellow laps and especially when the cars are on pit lane, with its 60 mph speed limit.

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The point is whether it's the race or investments, in order to achieve your average speed or return, you will likely not experience speeds lap by lap near the average speed for the race.  Just as you will likely not experience returns on your investments year by year near the average returns that you will experience over the long term.  Some laps (years) will have much greater speeds (returns) while others will have much slower speeds (lower returns).

Drivers in the Indianapolis 500 need patience and discipline to make it through the long 200 laps and 500 miles.  They realize the race isn't won on the first lap.  They also realize that an ill-timed pit stop or yellow flag, during which they are only going 60 to 80 mph, does not destroy their progress in moving towards their ultimate goal of the finish line.  They remain focused and do not get rattled.

Investors also need patience and discipline to make it to their long term goals.  You must realize that investing is not a race, it is a long term journey and it certainly is not won or lost on the first lap.  Pit stops and caution flags happen in racing.  We expect them.  They are just part of the sport.  And although we expect them and we know they will happen, we don't know when.  Yet, even with these slow- downs, drivers and cars go on to achieve respectable average speeds.  These slow-downs also occur during your investing lives on your way to your goals.  Just like in racing, we expect them to occur.  We know it's going to happen but we do not know when.   It does not mean that we give up.  It's part of investing.

Although the market is doing quite well right now, when one of those expected pit stops comes along - because we know they will - we just don't know when, remain disciplined, focused and patient with your long term goals in sight.  You've got to stay in the race, even during the yellow flags and pit stops, to be in it at the finish line.

The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization. The Dow Jones U.S. Select REIT Index intends to measure the performance of publicly traded REITs and REIT-like securities. The MSCI EAFE Index is an equity index which captures large and mid cap representation across Developed Markets countries around the world, exluding the US and Canada.

All indices are unmanaged and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance does not guarantee future results