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4-benefits of holding stocks for the long-term

A LONG-TERM PERSPECTIVE . . . . . . .

A Long-Term Perspective on the
Stock Market Downturn

Prior to Feb. 2, the stock market had been through a remarkably tranquil period. Since that date, the U.S. stock market has experienced multiple days with drops of 2 percent or more in a short period of time. Here, though, we will focus on the long-term investing concepts you should keep in mind, as well as historical context for market moves of this magnitude.

Short-Term Forecasting

Markets are notoriously difficult to forecast over any horizon, and this difficulty is only amplified over shorter periods of time. Nevertheless, this won’t stop some market “professionals” from trying. You would be wise to ignore these forecasts in your own decision-making. Yes, markets are currently extremely volatile, but that volatility might not continue and no one can reliably know whether stocks will move up or down from here. In fact, no one can even clearly know what caused the drop over the last week. Some commentary we have seen points to inflationary concerns while other pundits blame anxiety around the U.S. budgetary process. Still others believe the market is concerned the Federal Reserve may raise interest rates too quickly. Who’s to say which, if any, of those explanations are correct, much less what that implies going forward. What we do know, though, is that over the long term, you can expect to be rewarded for investing in a low-cost, diversified portfolio of stock funds.

The recent past shows us just how wrong consensus, short-term forecasts can be. Two recent examples are the post-financial-crisis prediction of higher interest rates and the expectation that the stock market would decline following the 2016 presidential election. Both predictions were clearly wrong, and investors who acted on them instead of focusing on the long-run evidence that markets tend to reward risk-taking were harmed.

Your Plan Incorporates Risk

One of the advantages investors have today compared to investors in the early part of the 20th century is that we now have decades-worth of data to help us understand long-run returns and risks. Our partner, BAM Advisor Services, maintains an extensive database of the risk profiles associated with the portfolios that we recommend to clients. This data allows us to incorporate risk into the way we build your financial plan, meaning that outcomes like the market falling by 2, 3 or 4 percent over a handful of days already are reflected in our recommendation. The BAM Advisor Services Investment Policy Committee is well aware that these events — however unpredictable — will eventually happen, and we therefore imbed this knowledge in the comprehensive planning process that results in your portfolio allocation.

Putting Market Risk in Historical Context

The following graph plots the historical annual return of the U.S. stock market in each year (in blue) from 1926 through 2017 and the largest intra-year decline (in light blue outline) that occurred in each of those years.

Annual Stock Market Returns and Intra-Year Declines
There are two primary takeaways from this graph. First, as we all know, the stock market goes up far more often than it goes down. Second, but possibly less well known, virtually every year includes a period of time where markets fell precipitously. It’s clear, though, that these intra-year declines don’t necessarily signal whether the market will be up or down over that particular year. But it does show that stock markets have and always will be risky, particularly over shorter periods of time.

Are There Any Actions to Take?

Given what we know, we obviously don’t recommend making drastic changes to your portfolio allocation as a result of short-term market moves already accounted for in the planning process. Your portfolio is well-thought-through and built to be highly diversified. But are there any other actions worth considering? If you haven’t recently, now could be a good time to reassess your investment plan from a long-term point of view. We’re always here to help with that endeavor.

Larry Swedro at Computer Monitors

Swedroe: Checking In With The ‘Gurudex’

Larry Swedroe

One of my favorite sayings about the market forecasts of so-called experts is from Jason Zweig, financial columnist for The Wall Street Journal: “Whenever some analyst seems to know what he’s talking about, remember that pigs will fly before he’ll ever release a full list of his past forecasts, including the bloopers.”

You will almost never read or hear a review of how the latest forecast from some market “guru” actually worked out. The reason is that accountability would ruin the game—you would cease to “tune in.” But I believe forecasters should be held accountable. Thus, a favorite pastime of mine is keeping a collection of economic and market forecasts made by media-anointed gurus and then checking back periodically to see if they came to pass. This practice has taught me that there are no expert economic and market forecasters.

Thanks to research compiled by the team at InterTrader, we can examine the 2015 stock market recommendations from 16 leading investment banking firms. They produced what they called the Gurudex.

How The Gurudex Works
InterTrader’s prediction data was sourced from The Motley Fool website for the period from Jan. 1, 2015 through Dec. 31, 2015. They collected the date of the prediction, the starting and ending prices, and the prediction itself (buy or sell). Because almost all the predictions did not specify a “time frame” for the investment, they provided results for 30-, 90- and 180-day investment periods, though all positions were closed out at the end of the year.

A guru’s prediction was deemed accurate if the sell price was higher than the buy price for the selected investment period—a very low bar. When reviewing the results, keep in mind that they do not account for transaction costs. The following is a summary of their findings:

  • For the 30-day investment period, 55 percent of the recommendations produced a gain. The total return of all the forecasts was just 0.8 percent, less even than the return one could have earned using an FDIC-insured deposit account from an online bank. It’s also less than the 1.3 percent return of Vanguard’s 500 Index Fund (VFINX), which does include all costs. Nine of the 16 investment banking firms posted accuracy percentages above the 50 percent mark, and six came in below. The highest accuracy rate was 74 percent for Barclays. However, the total gain of the firm’s predictions, before trading costs, was just 2.5 percent. The lowest accuracy rate was 33 percent for Mizuho. And that firm’s total return was an ugly -11.2 percent.
  • For the 90-day investment period, 49 percent of the recommendations produced a gain, with the aggregate average loss being 1.5 percent. Now, just seven of the 16 firms had an accuracy rate above 50 percent, and seven had an accuracy rate below 50 percent. Nomura posted the highest accuracy rate with 70 percent. However, the total return of the firm’s predictions, even before expenses, was -2.3 percent. Citicorp now had the worst accuracy rate at 14 percent. Its total return was -14.1 percent.
  • For the 180-day investment period, just 42 percent of the recommendations produced a gain, with the aggregate average loss being 3.7 percent. Only three of the 16 firms had an accuracy rate greater than 50 percent, while 10 of them had an accuracy rate below 50 percent. BMO Capital Markets had the highest accuracy rate at 58 percent, but its predictions produced a total gain, before expenses, of just 0.8 percent. Amazingly, Canaccord Genuity put up a 0 percent accuracy rate. I don’t think you could get a score of zero if you actually tried to do that. Its predictions produced a total return of -12.9 percent.
  • Using the end of the year, 43 percent of the recommendations produced a gain, with the aggregate average loss being 4.8 percent, pre expenses. Just four firms had accuracy rates above 50 percent, while 10 had rates below that figure. Nomura’s 60 percent accuracy rate was the highest, although its total gain, before expenses, was just 2.8 percent. Citicorp’s 14 percent accuracy rate was the lowest, and its recommendations earned a total return of -3.1 percent.

Conclusion

The preceding data serves as a reminder of the wisdom in Warren Buffett’s words of advice on the subject of the value of stock market forecasters: “We have long felt that the only value of stock forecasters is to make fortune-tellers look good. Even now, Charlie (Munger) and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.