It’s a classic and well-known Seinfeld scene. It starts with George sitting in the coffee shop, lamenting about his life. He tells of how much promise he had, but every decision he has ever made has been wrong.
He finally says, “It became very clear to me sitting out there today, that every decision I've ever made, in my entire life, has been wrong. My life is the opposite of everything I want it to be. Every instinct I have, in every day of life, be it something to wear, something to eat . . . it's all been wrong.”
It’s probably how a lot of investors are feeling these days. Look, investing is tough. That may be the most important thing you need to know about the equity markets—right now and always.
And here’s why: Trees don’t grow to the sky, and investments don’t move up at a 45 degree angle. Anyone who promises returns like that will most likely be sharing a cell with Bernie Madoff one day.
Investors who have a well-thought-out financial plan and a corresponding well-thought- out investment strategy already know this. Through the process of creating a plan, they are aware of the fact that their portfolios will go up and down in value. That’s why they only have appropriately segmented money at risk—it’s called risk capital.
With a good plan, they manage to remove the anxiety of the up and down natural order of the equity markets.
It’s the investors who don’t have a plan that fall victim to the seesaw motions of the markets. Their anxiety drives them to panic.
And it’s not just me saying it; it’s also the newest DALBAR study that was released in March of 2012. According to its website, DALBAR has been measuring the effects of investor decisions to buy, sell, and switch into and out of portfolios over both short- and long-term timeframes.
You can buy the report yourself on the website, but here’s what it says in one sentence: Investment results depend heavily on investor behavior. In fact, the report shows that over the past 20 years, the average investor made an annual return of 3.49 percent, compared to an annual return of 7.82 percent for the S&P 500 over the same time.
Here’s why: The average investor panics and ultimately sells when the market goes down then buys back in after the market has recovered. This is otherwise known as “buy high and sell low.”
By the way, it’s stupid and avoidable.
Let’s look at how often this happens. Thanks to Ned Davis Research, I’ve recently learned that there have been 294 dips of 5 percent or more in the S&P 500 since 1928. Put differently, that’s about three or four times a year that an average investor can completely screw up and do something stupid (I’m using the mean here).
It gets better.
The S&P 500 has dipped over 10 percent exactly 94 times since 1928. That’s just a little over one time per year (again, mean). Fifteen percent dips happen every other year and 20 percent dips every three years or so.
That’s a lot of opportunity to screw up, and the DALBAR study proves that individual investors are taking full advantage of their opportunities. The sad part is that the study quotes a 3.49 percent return for the average investor. That means that there are investors doing WORSE than that. But it also means there are people doing better, too.
How are they doing better? Well, here’s where I get to share the secret since you read this far.
They are doing the George Costanza. They are doing the opposite. Later in the same scene, George quickly decides to do the opposite of his natural instincts.
He says, “No, no, no, wait a minute, I always have tuna on toast. Nothing's ever worked out for me with tuna on toast. I want the complete opposite of tuna on toast. Chicken salad, on rye, untoasted . . . and a cup of tea.”
People doing better than 3.49 percent are probably following a financial plan and doing the opposite of everyone else. They are taking their risk capital and buying when the markets have sold off.
They are buying low and selling high. And given the Ned Davis numbers, they have three to four times a year to get things at a perceived 5 percent discount and about one time a year to get a 10 percent discount. Meanwhile, every other year yields a 15 percent discount opportunity, and every three years an epic opportunity rolls around to get in on a severe undervaluation of greater than 20 percent.
The market sold off in May. What does your financial plan call for?
And just so everyone knows, chicken salad is not the opposite of tuna. Salmon is the opposite of tuna. Salmon swim against the current, and the tuna swim with it.
David B. Armstrong, CFA, is a managing director and cofounder of Monument Wealth Management, a full-service wealth management firm in Alexandria, Va. Monument Wealth Management is backed by LPL Financial, an independent broker-dealer and Registered Investment Advisor. David has been named one of America's Top 100 Financial Advisors for two straight years by Registered Rep Magazine (2009 and 2010, based on assets under management) and has been interviewed by several national media sources over the past several years. Follow David and Monument Wealth Management on their blog Off The Wall, on Twitter at @MonumentWealth and @DavidBArmstrong, and on their Facebook page. Securities and financial planning offered through LPL Financial, Member FINRA/SIPC.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. All performance references are historical and are not a guarantee of future results.