Photo credit: Robert Rescot
The Greatest Spectacle in Racing, the Indianapolis 500, returns to the Indianapolis Motor Speedway (IMS) this weekend for its 102nd running. I'm a big fan of the race, the history of the race and the track itself. Just as I'm a student of the history of the track, I'm also a student of investing. The 500 and investing have a lot in common.
Many successful long-term investors don't get too excited when things are going well, and they don't get down when things are going poorly. Instead, they stick to long-term plans that are built around their financial goals. The best way to reach those long-term goals is to remain disciplined and patient – whether you are experiencing joy over the markets 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 December 31, 1997, and December 31, 2017, the stocks in the S&P 500 index returned an average of 7.20% annually.* Yet the average stock investor only gained 5.29% 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. Instead of remaining disciplined and patient, they let their emotions rule and try to "time" the market - jumping in and out as stocks rise and fall. The result is usually very predictable.
The Parallels Between the Indianapolis 500 and Investing
Last year Takuma Sato won the 500 with an average speed of 155.395 mph. Sato also had the fastest race lap at 226.190 mph. When you look at just the 155.395 mph as Takuma Sato'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 155.395 mph during a 500-mile race?
Many laps of the race have high average speeds but then a yellow flag can come out because of an accident and the cars slow down behind the pace car. Consider that the average speed for caution laps is 75-80 mph, significantly slower than racing speeds. There were 11 cautions during the race for a total of 50 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 2017 has averaged 10.27% per year. This is like Takuma Sato's average race speed of 155.395 mph. Over those 92 years, the market had an annual return within two percentage points of the average of 10.27% in only 6 years. That's like saying that Sato turned lap speeds near 155 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 Sato's fastest lap of 226.190. Other times the market is way down, like 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. Did you know that the stock market has had a 10% or more decline about once per year, on average, since 1948? So, just like yellow flags or pits stops, market pullbacks are common occurrences.
Focus on the Finish Line
The point is, whether it's the Indy 500 or investments, in achieving your average speed or average 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 or in any one year. 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 tremendous 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 don't know when. It doesn't mean that we give up. It's part of investing. Remain disciplined and patient and focus on your long-term goals. You've got to stay in the race, even during the yellow flags and pit stops, to be in it at the finish line.
Footnotes: 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, excluding 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