The stock market has experienced a fairly steady rise upward this year with the S&P 500 returning 11.88% through the end of April. Real estate as an asset class has performed even better, with the DJ US Select REIT TR index posting a 14.09% gain so far. Growth has outperformed value thus far in large caps, mid caps and small caps. International (MSCI EAFE NR USD) is the lowest performing equity asset class though the end of April with an 8.69% return. Bonds (BarCap US Agg Bond ) have returned 1.41%. (Souce: Morningstar as of 4-30-2012)
We only have to look to last year to remember that things can and do change. Through the end of June the S&P 500 was up 6.02%. But third quarter saw a 15.10% decline, followed by a fourth quarter gain of 11.82%, with the S&P 500 finishing 2011 with a 2.11% gain.
It’s been a great start to the year but it has not been without volatility. We have seen days where the market (DJ Industrial Avg) has dropped by 100 plus points.
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 1992 and 2011, the stocks in the S&P 500 index returned an average of 7.81% annually. Yet the average stock investor only gained 3.49% 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.
I’m an Indy 500 fan and it’s the month of May so I’m going to use a racing analogy here. Last year Dan Wheldon (may he rest in peace) won the 500 with an average speed of 170.265 mph. The fastest race lap was from Dario Franchitti at 224.667 mph.
When you look at just the 170.265 mph as the average 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 170 mph during a 500 mile race? It’s similar to saying, if the S&P 500 can return 11.88% through the end of April, shouldn’t it return 35.64% this year?
The first 17 laps of the race saw a high average speed but then the 18th lap a yellow came out because a car hit the wall and all the cars had 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 seven other cautions during the race for a total of 40 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 2011 has averaged 9.8% per year. This is like Dan Wheldon’s average race speed of 170.265 mph. Over those 86 years the market had an annual return within two percentage points of the average of 9.8% only 5 out of 86 years. That’s like saying that Wheldon turned lap speeds near 170 mph only 12 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 Franchitti’s 226 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.
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 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 pit stops, to be in it at the finish line.
Securities and Investment Advisory Services offered through Transamerica Financial Advisors, Inc. (TFA) Member FINRA, SIPC, and Registered Investment Advisor. The Standard & Poor’s 500 (S&P 500) is an unmanaged index of 500 common stocks traded on the New York Stock Exchange that is widely used as an indicator of market trends. The Dow Jones Industrial Average is an unmanaged index of common stock that tracks changed in stock prices of the 30 most significant and commonly traded U.S. Industrial stocks of the New York Stock Exchange. Past performance is no guarantee of future results. The market value of securities will fluctuate and may incur a profit or loss. The index returns listed do not include transaction costs or tax considerations. The performance of these indexes do not reflect any fees and charges associated with investing. It is not possible to invest directly in an Index.