Nobody can have all the answers to this pivotal question. In our view, the safest route to outperforming returns depend on an integrated three-tier strategy:
- Embrace “time” as your best friend.
- Dive into an S&P 500 index fund to take thinking out of the equation.
- Employ Dollar Cost Averaging to quell the threats of panic and greed
Here’s an insight into our thinking
Vanilla bank savings and quality bonds currently yield uninspiring annual returns between 1.0% and 3.5%, languishing under the weight of low-inflation interest rates. Conversely, large corporation profits thrive wherever leveraging is an inexpensive resource.
Stock pundits routinely echo the fact that the 500 biggest quoted companies (i.e., the S&P 500) have garnered average annual yields of 10% for close to a century. That’s an enticing proposition for any investor to effectively ride out volatility between one’s early twenties and retirement years.
Despite a stellar history, why do so many horror stories plague stock investing?
Joe and Jane Public, and even sophisticated traders, regularly step into the stock-investing arena only to lose their boots. The culprit boils down to frequently breaking the rules. Let’s explain:
- Patience and investor resilience are assets.
- Impatience, greed, and fear kick in as serious liabilities.
- Underperforming stock returns tend to align with the accelerated pace of an investor’s in-and-out stock market movements.
- Making matters even worse is that these knee-jerk reactions inevitably occur at the most inopportune times.
Here are some mind-blowing statistics (from Business Insider):
- A recent S&P 500 randomly taken, twenty-year return (1993 – 2013) was an annualized average of 9.2%.
- If for some reason you were not on the stockholder register for the ten best days in that period (i.e., 0.14% of the 7300 total days), the return fell to 5.4%.
- Missed the best twenty days, and you only saw a 3.02% return.
- Missed the best forty days, and you kissed positive returns goodbye altogether (i.e., minus 1.2% annually).
Moving in and out of stocks is like spinning a roulette wheel with the company’s dividend register, and you’ll probably bypass many critical high-performance days. Trying to pick and choose the best 0.5% of days in real-time is a fool’s errand. Alternatively, it doesn’t take brain-power to know that once in, staying put means you’ll be there when the boom times come around plus all dividends. Our point is this: time-disciplined investing is the Holy Grail to make money in stocks.
The most-heard excuse in the way of sound investing – “I’ll wait until the stock market is safe before diving in.”
“Waiting for safety” often morphs into taking the plunge as prices go up (i.e., the fear of “being left behind” syndrome). On the contrary:
- The best investment performance springboards off lower prices after they’ve corrected down. Therefore, dips are indicative of buying opportunities, not bailout signals.
- On the other side of the coin, best appreciation days are least likely after prices have spiked.
The sure formula for ‘buying high and selling low” is getting out in the “panic period” or piling in when prices are rising. Severe reactions in any investment period are in themselves a flashing red alert.
Why an S&P 500 Index fund?
It facilitates small $ investing in a big cross-section of stocks for significant diversification. Then, low internal turnover renders them tax-efficient. Also, minimal transaction costs are a huge plus. In most cases, the fund managers guarantee you at least the market’s return, less the low fees paid.
The five hundred ranking stocks make up the index of these funds. Each invested unit ties into all five hundred. Knowledge of each separate company in the index is irrelevant for success. So if the 10% composite S&P return over an extended period is good enough for you, this investment category is a stress-free place to be.
There’s no better way to smooth out the ups and downs in the market – a tactic based on investing the same fixed dollar amount over regular intervals. Index prices up, down, or sideways at the time of each installment doesn’t change the system. In this disciplined way, you remove the temptation to time the market, picking up all market conditions in a balanced manner. Highly successful pension funds are prime examples of this principle at work.
Drip, drip, drip, permanent investing in S&P 500 index funds is a no-brainer. Here are selected links to help you learn more: