Don’t be a victim of the lackluster stock market
Reprinted courtesy of MarketWatch.com.
To read the original article click here
Stock market returns so far this century have been lackluster, at least as measured by the performance of the Standard & Poor’s 500 Index SPX, -0.70% , otherwise known as “the market.”
Worse, many people expect returns in the coming years to fall behind those of the “golden years” of the late 20th century.
If that’s the bad news, there’s still plenty of good news.
For starters, expectations are really just hot air. Not even the highest-paid gurus and economists know the future. We aren’t stuck with their gloomy predictions, but neither can we count on their optimism.
I’ll show you two effective ways to get (and stay) ahead of the S&P 500 over the long run. First, you can diversify. Second, you can adopt good habits and attitudes.
(And if you do those things correctly, you may amplify your success by running into good luck. I discussed this last point in a recent article you might find interesting.)
Let’s quickly dispense with some of the bad (or at least discouraging) news about the S&P 500. From 1975 through 1999 (truly a “golden years” period), the index compounded at 17.2%. But from 2000 through 2015, the rate was only 4.1%.
But wait. After 10 awful years (2000-2009) in which it compounded at a minus 0.9%, the index bounced back, growing at 13% from 2010 through 2015. Is this a sign the good times are back for investors? Apparently not. For the 12 months ended April 30, the index was up only 1.2%. Sigh.
If those figures contain obvious helpful hints for investors, they have escaped me. You can slice and dice past performance in infinite ways, but you still can’t know the future.
So what can you do?
First, you can diversify. A very easy way to do that is to divide an equity portfolio into four asset classes: U.S. large-cap blend (represented by the Standard & Poor’s 500 Index), U.S. large-cap value, U.S. small-cap blend, and U.S. small-cap value. For more, check out this recent article.
Remember those years 1975 through 1999, when the S&P 500 grew at 17.2%? Well, at the same time, the four-part portfolio I just described grew at 19.8%. Over a quarter of a century, that makes a huge difference. An initial investment of $10,000 would have grown to $528,677 in the S&P 500, or to $914,998 in the diversified combination.
From 2000 through 2015 when the S&P 500 grew at only 4.1%, the four-part combo grew at 8.4%. On an initial $10,000 investment, that’s the difference between $19,020 and $37,435.
Here’s a simple table showing the index vs. this four-part combo over some historical periods.
|Years||S&P 500 Index||Four-part diversification|
- · Annualized rate of return, assuming annual rebalancing of diversified portfolio.
Over and over and over, the benefits of diversification have been documented. Sure, in every period there will be one asset class that leads the others; sometimes that asset class will be the Standard & Poor’s 500 Index. But over the long haul, there’s just no substitute for diversification when it’s done right.
I could go on and on, but if the article in that link doesn’t convince you, I don’t think anything will.
The second major thing you can do is bring the right stuff to the party. You might think investment results just happen, but you would be wrong. What you bring to the party – specifically your habits and attitudes – can have an enormous impact on your success.
The best investors cultivate lifelong habits of savings and thrift. Obviously you can’t be a successful investor without money to invest; for most of us, that means you have to regularly add to your savings.
Thrift impacts investment results in a couple of ways. First, thrifty investors pay attention to costs and fees, keeping more of their returns for themselves. Second, thrifty habits can control your living costs, and that means you don’t require unrealistic investment returns – or high risks.
Here are three other excellent habits of successful investors:
- They set measurable goals for themselves.
- They make written plans for achieving those goals.
- They regularly monitor their progress toward their goals.
Pretty simple, stuff!
Our attitudes are actually extremely important assets: They shape our behavior almost automatically, while we aren’t watching.
Some years back I asked my investment advisor colleagues to identify the most common attitudes they had observed among the best investors they knew. A handful of key attitudes emerged. Here are four:
- First, investors must trust the future enough to be willing to consistently do the right things even when the outcome is uncertain.
- Second, every investor needs resilience, the ability to bounce back from the inevitable slings and arrows of the market – and of life itself, for that matter.
- Third, successful investors need perspective, the ability to look beyond today’s headlines, and recognize the difference between what’s really important and what’s not. Do you remember what was happening in the market exactly five years ago today? I don’t either, and by now it really doesn’t matter. That’s perspective.
- Fourth, investors need patience. The best investors know that time is their ally, and they can wait for results when that is necessary. Impatience is dangerous, often leading investors to do dumb things.
My final prescription for overcoming a lackluster stock market is luck. Luck is more likely to be on your side if you master the right habits and attitudes, so that when an otherwise random event occurs, you’ll see it as an opportunity and (this is crucial) you’ll be in a position o do something about it.
The bottom line here is simple. While you are diversifying your portfolio, be sure to cultivate helpful habits and attitudes. I can’t promise this will make you rich. But I can promise it will put you ahead of the game.
For more interesting and useful insights on investing, join me for my latest podcast, “Why not put all your money in small-cap value?”
Richard Buck contributed to this article.