We Love Volatility!

Just not the down kind.

This is an important message to investors and work-plan administrators about expected returns. Let me start by giving some perspective…

What do you expect from your checking account?

You expect that only the money you put in will ever be there. If you logged into your account tomorrow and the value in your checking account was $1000 more than you put in, you’d be surprised. You would not have expected it. You should not expect that. There may be a few dollars earned in interest, but normally you will never have much more than you put in. Just as importantly, you can expect that there will never be anything less than you put in (unless you take it out). You are clear about this expectation. You cannot expect better. You do not expect worse.


What do you expect from a 50/50 raffle game like the ones we see offered at a football game?

When you put $10 toward a 50/50 ticket, do you expect to make money? No way. You are just glad to participate in the fun and help the charity sponsoring the event. Part of you might dream of what it would be like to just once be the guy or girl on the jumbotron jumping up and down because your ticket number was drawn. But that rarely happens. And you would never “expect” those results from the raffle.


What do you expect from your investment portfolio? More to the point – what should you expect?

You should expect three things:

1. It goes up sometimes. Sometimes it goes WAY up, really fast. Like from March of 2009 until March, 2010. Many stock portfolios actually doubled in size during that 12 month period. That’s a 100% return in one 12 month period. I received exactly zero phone calls from folks who did not like “volatility” during that 12 month period. True.

2. It goes down sometimes. Sometimes it goes way down. Depending on how you track it, during the past 90 years we have seen the market go down by more than 30% eight or ten times. Just three years ago the DOW went down 56% in just under 17 months. In the early 2000s the S&P 500 went down more than 50%. In 1987 it went down 20% in one day. In 1973 and 1974 it went down almost 50% over a two-year period. In the 1930’s it went down more than 60%, depending on how you measure it. It happened another 6 or 8 times in the years between. Sometimes it’s over in a week. Sometimes it takes a month or a year or a few years.

3. It goes up in the end. There has not been a 20 year period where a well-diversified and rebalanced stock and fixed-income portfolio has not outperformed inflation by 6%. In the past ten years, inflation has been low. In the past 10 years a well-diversified portfolio has achieved better than a 10% return. In the 1980s, inflation averaged nearly 10%. The same well-diversified portfolio beat inflation by more than 6% by averaging in the high teens for over a decade.


Here is the important message:

The market cannot be predicted with the accuracy necessary to bring value to stock investors. The discipline, diversified stock investor can expect to beat inflation by around 6% over his or her life time. Be disciplined and be diversified. If you are concerned that you or your employees may be lacking in either of these important matters, call my office.


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