Time is Money
by Dave Thrifty
Last Month we looked at Barclays' Equity Index going back to 1945 and how well equity investments have performed over long periods.
There is little doubt that equities are a dangerous place to be in if you have a short investment horizon. But if you have ten or more years before realizing your investment, equities will generally come out on top with one big proviso. You really do need the psychological equipment to handle the bleak downturns that equities will surely bring. It’s been my experience that there’s no free ride; anywhere in life.
This Month I came across the past history of the Standard & Poor’s 500 index.
This index has not suffered a loss in any 15 year period going back to 1926
This basket of the 500 large cap U S stocks with dividends reinvested, delivered average annual gains of 11.3% between January 1926 and December 1999 easily beating inflation
- the No 1 enemy of investors.
If we compound 11.3% each year in real money terms what does it mean?
A US$1,000 investment in the S&P 500 in January 1926 would have grown to
But not many of us invested US$1,000 in 1926 and are still running around Thailand with nearly 3 Million bucks. The point of the illustration is to make a case for sticking in there.
A more realistic scenario to make the point is the following.
Had you invested US$10,000 in the S&P at the end of December 1989.it would have begun ominously. Stock prices had crashed in October 1987 but the benchmark Dow Jones Industrial Average clawed its way back over the following year. By the middle of 1990 the Dow had risen well above its precrash levels. But as the US economy slumped into recession, the market tumbled sharply losing roughly 20 percent between July and October 1990.
After that the tide turned.
For much of the next eight years the stock market never looked back. The $10,000
which had ridden roughshod in the early years by December 1999 was worth $53,243. Another proof that time is money
Of course it’s easy being wise in hindsight. The wounds of a 20% downturn on your portfolio in real terms at the time of the fall is forgetting about your grandchild’s education forgetting about that new holiday home and if you’re elderly a more modest retirement than planned.
Even though we are familiar with the investment benefits of staying in the market how many of us who say invested $1 million in 1989 would have sat tight when we had lost
$200,000 ? If we had of course we would have had a nest egg of over 5 million 10 years later.
I’m making this point so strongly because I know that not all of us are equipped to handle these crippling losses
Look at these two scenarios.
You are given $1,000. Choose between (a) a sure gain of $500 or (b) a 50% chance to gain $1,000 and a 50% chance to gain nothing.
Question 2 you’re given $2,000 Choose between (a) a sure loss of $500 or (b) a 50% chance to lose $1,000 and a 50% chance to lose nothing.
Look closely at the problem. The possible outcome from each situation is the same but how the question is phrased can influence your decision
Richard Thaler of the University of Chicago maintains that we avoid risk to capture additional gain but we will take a risk to avoid a loss. These two questions if answered honestly seem to illustrate that:
The bottom lines when all the little games are over is how well will you sleep at night after a 20% drop in your portfolio. You might have the dream of increasing your wealth in the future but remember you could loose another 20% in the next month.
Past historical performance is a great guide but the guarantee of future performance is never there in equity markets. Think hard and long before jumping in. If you choose equities make sure you have the time and the stomach for them.