- Investment Management
- Investment Management Incentive
- What Do You Do?
- Summary
This chapter is from the book
This chapter is from the book
This chapter is from the book
What Do You Do?
So, what can you do to protect and grow your financial assets? You can continue to be smooth-talked by the “professionals” and diversify into a variety of mutual funds and suffer outrageous fees, or you can do the investing yourself. To many, the do-it-yourself method is scary. Not only have they been intimidated by the pros’ jargon, but they are also afraid that it requires learning a whole bunch of new things and that it may involve mathematics or other subjects they were not the best at when in school. To a slight extent, there is some basis for the fears, but not to the level that professionals would like you to believe. Most information necessary is publicly available for small fees, considerably less than any management, administrative, trust, or brokerage fees you would otherwise pay. You might have to do a little work at regular intervals, perhaps weekly or monthly, but that work shouldn’t take more than an hour per session, provided the appropriate financial information is present. From this analysis, you can outperform the market averages, if history is a guide, and feel more confident that your investments are protected from substantial loss.
Why the Stock Market?
Why the stock market? Stocks have proven to be the best investment over the past 200 years. Wharton professor Jeremy Siegel calculated that in the past two centuries, the U.S. stock market had a total average return of 6.9 percent per year. This, after accounting for inflation, is often called the “real” rate of return. No other investment category has attained results even close to this outcome. The U.S. government’s long-term bonds averaged 3.5 percent, and short-term bills averaged 2.9 percent over the same period. Since 1926, stocks have averaged 6.9 percent, the same as over the entire 200-year period; bond performance declined to 2.2 percent per year, and U.S. Treasury bills declined to 0.7 percent per year. The stock market results are striking. They show that stocks have worked effectively as a hedge against inflation. Inflation is with us, and it accelerated after the U.S. went off the gold standard. It is unlikely that we will return to a gold standard any time soon, and so it is probable that inflation will continue as well. It is the necessary evil of paper money.
Therefore, U.S. stocks, over the long and recent term, have been the best investment. In addition, according to Siegel, over no 30-year period have stocks ended up below their beginning prices. The presumption here is that if you can hold a stock portfolio for 30 or more years, you will always make a profit. I don’t buy this thesis. First, there hasn’t been many 30-year periods to arrive at a good statistical test. Second, the presumption measures only the performance of those stocks that lasted for 30 years. Finally, most people are not willing to wait 30 years to see if the theory is correct. However, it is undeniable that U.S. stocks, in general, have had a relatively high, sustained growth rate when compared to other financial assets.
By the way, when I mention holding stocks, I mean a portfolio of stocks and not necessarily putting all of your cash into an individual stock for 30 years. No one is capable of predicting anything 30 years from now. Just think of guessing who the president will be or what interest rates will be 30 years from now. Indeed, I am not confident about predicting the market even three months ahead. In addition, there are times when most investments are less than prudent; market trends rise and fall in the short term, and it is impossible to predict longer-term cycles. In some ways, it depends on how far away from the average 6.9 percent per annum the stock market is at any one moment. Siegel’s calculations suggest that at any one time, the stock market can deviate substantially from the average 6.9 percent, but over time, the average of annual returns remains at the established norm. It does not suggest that the stock market, with its mean return of 6.9 percent per year for 200 years, will be up 6.9 percent each year. However, as you look at many years—some with large gains and some with large losses—you see that the overall average return was 6.9 percent. This is the basis for the argument of not worrying about market timing—trying to time the oscillations about the average to improve on the portfolio return. We explore this in more detail when we discuss specific methods for reducing capital risk.
There is also a long-term risk to the stock market. You must not put too much trust in historical figures. According to Harvard ex-professor Terry Burnham, the only stock markets over the past 200 years that have not declined to zero are the U.S. and U.K. markets. All other world markets have gone bust at some time. This suggests either that the constant rise in the U.S. market is somewhat accidental or that it is exceptionally strong and well regulated. Survival until now, however, is not a guarantee that it will survive in the future. This mislaid assumption is why many investors own stocks and won’t sell them. They believe that the rise will continue forever. It will not. Therefore, we must be aware that at some time in the future, the U.S. stock market will change from its historical 6.9 percent annual growth to something considerably less and it may even decline. This is the eventual outcome of all nations and is why the “buy-and-hold” investment philosophy is ultimately flawed.
On the other hand, the rise in stock prices can continue for many years to come, and I hope it will. This is my assumption because I also introduce a simple method of protecting a port-folio from substantial capital loss during any kind of market decline. With this defensive protection method, you will not have to worry about a major market decline—short-term or permanent. In the meantime, as the stock market progresses upward, you will be able to take advantage of it.