We Have Met The Enemy, and He Is Us!
When it comes to investing, we are our own worst enemy.
Take a look at the graph above, showing you returns of different types of investments over the last 80 odd years. Obviously, stocks have trounced the returns of bonds, cd’s and savings accounts, and you might ask yourself why any long term investor would invest invest anywhere else? The 6 to 9 percent extra annual return over other types of investments adds up enormously over time, due to the effects of compounding.
The problem is, very few people achieve a 9% or 12% return over time. A long term study of mutual fund history has shown that the average mutual fund investor’s return over time is just over 4%. The problem is that few people have the stomach to suffer through the downturns. By getting out too late and back in too late, they end up worsening their results significantly.
Despite their advisor’s admonitions, most investors react in the worst possible way in a stock market crash. At the first 10% or 15% drop, they tell themselves that they are in it for the long run and they can await the rebound. Surely enough, the market soon turns up giving them renewed hope, and they congratulate themselves at having held the course. But then the market snaps back down suddenly and drops fast. Soon they are watching their investments drop at what seems to be an accelerating pace, and at around 20-25% losses most investors finally throw in the towel. Others hold out longer, but then bail at a 40% loss. Who can blame them? It’s hard to see your life savings disappear in a matter of weeks or months.
If investors got right back in at the first signs of a turnaround, things might be ok. But most investors wait longer, until they are “sure” the market recovery will hold. Of course,by that time the market has recovered 15%, 20% or 25% , so by waiting too long they’ve allowed a large part of the recovery to slip through their fingers.
In those situations, there are only two winners, those that can suffer through the downturns without ever selling, and those who get out early and get back in early. Probably fewer than 1 investor in 20 fits that pattern, as unfortunately, that behavior goes against basic human nature.
It is utterly impossible to achieve a good upside potential on a portfolio without having the risk of losses. Inevitably, the more upside potential a given investment has, the more risk you must take. This is the nature of investing, and it will never change.
That said, it is possible to maximize rewards for any given risk level, or vice-versa, minimize risk for any given maximum reward. Two strategies may have the same maximum upside potential, but one may have much lower downside risk. To find that perfect balance, attuned to one’s risk tolerance and time frame, is the goal of every good investment strategy.
Every investor’s risk tolerance and time perspective is unique. On these pages you will find numerous approaches that will allow you to achieve the best balance of risk and reward. Choose the strategy carefully that that fits your needs, and then try not to allow your emotions to lead you deviate from it.