[The Risk of Not Being in the Market]
Things we know;
-Over time, a well diversified portfolio has a positive return-See Malkiel below.
-Over time, the average investor does not achieve returns equal to those of the S&P 500-
See Dalbar chart below
-Fear and greed are basic emotions.
-Past performance does not guarantee future results.
There was an excellent article in the Wall Street Journal on November 18, 2010 by Burton Malkiel author of A Random Walk Down Wall Street. The title of the article was Buy & Hold is Still a Winner. Malkiel showed a diversified portfolio for the so called lost decade (2000-2009) and compared it to the S&P 500 index for the same period. While it is true that you cannot invest directly in the index, the index is a worthy benchmark. The chart that accompanied the article showed that a $100,000 invested in the diversified portfolio beginning in 2000 would have been valued at $191,859 at the end of 2009 while the S&P 500 was valued at $93,717-an annualized gain of 6.73% versus an annualized loss in the S&P 500 of 0.65%.
A couple of observations are in order. First, the S&P 500 index which the talking heads use as the basis for declaring the time 2000 through 2009 as the lost decade is not a diversified portfolio. The S&P 500 index measures ONLY the largest 500 stocks in the United States.
Second, at first glance, you might say that an annualized return of 6.73% is not a great return. When you consider that in 2000, the S&P lost about 10%, lost about 13% in 2001 and lost a whopping 38% in 2008- three down years in the lost decade, the reality is that a diversified portfolio almost doubled your money and beat inflation. (S&P 500 Data from Yahoo Finance.)
Dalbar Research produces an annual study showing how the S&P 500 index performs over moving 20 year time periods versus how the average equity fund investor performs. Here are their results for the 20 year period 1990-2009;
CATEGORY 1990-2009 Annualized
Return
S&P 500 Index 8.20%
Average Equity Fund Investor 3.17%
Inflation 2.80%
After looking at the Dalbar Chart, the question becomes obvious. How does a non diversified index such as the S&P 500 beat the average equity investor? My answer? The emotion of fear causes the average investor to bail out of the market in years like 2000, 2001 and 2008 and then when the market goes back up, they get back in. It is called buying high and selling low. Not smart.
My final observation about the Malkiel article is this. It clearly points out that the portfolio must be rebalanced to have any chance of achieving positive results. In other words, Buy & Hold does not mean Buy & Hold and Forget.
Learn more about Free Market Investing at www.billmullen.org
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