Welcome back to The Money With Katie Show Rich Girls and Boys Where The Rules Are Made
Up and The Points Don't Matter.
At least that's how things feel right now in Hashtag This Economy, where the stock
market seems utterly unperturbed by the absolute shit storm that is raging around it.
We narrowly avoided a looming debt crisis, we have rising rates, we have record high
unaffordability of everything from blueberries to homes, and yet it's hard to believe.
But as of the time of this recording, we are recording on June 21st, the S&P 500 is
up 14% year-to-date, 14.5% to be precise, which defies all expectations and frankly all
common sense about what the stock market should be doing in 2023, given I'm wildly
gesticulating to everything around us right now, and I think therein lies the lesson.
When you ignore the advice to buy and hold, you are doing so at your own peril.
Those who jumped ship in 2022, they looked at the world around them, and they figured
you know what, I'm going to wait out the bleeding, and then I'll hop back in.
They're now looking at prices that are 14% higher than when they dipped out, unless you
think that these folks don't exist, or that only those who have not been inoculated
by the sound of my droning voice every week would make such a silly mistake, consider
this.
While the stock market returns about 10% per year on average before adjusting for inflation,
the average investor will only get about half that.
Let me say that again, the average investor's returns will be roughly half of what the
S&P 500 returns over the long term.
So let that sink in while we take a quick break.
So I've written in the past about how it's possible that the average 10% per year estimate
might not happen in the future, partially because assets are still relatively overpriced
right now, but I ended up settling recently on a far less sinister explanation for why
the average investor should not bank on 10% average returns, and that's that the average
investor, in other words, the average human being who is going to invest in the stock market,
that the study we are going to be unpacking today has data for, has a really, really hard
time ignoring their own psychology and buying and holding for the long term.
Instead, Dalbar, which is the company that studies investor behavior and investor market
returns, which sounds hella fancy, found that average investors earn below average return.
So here's an example.
For the years between 1999 and 2019, the S&P 500 averaged 6.06% per year.
This was mostly dragged down by the abysmal 2000 to 2009 returns after the dot com bubble
crashed and subsequent financial crisis in 2008.
But the average equity investor did not get 6.06%, they only earned an annualized average
return of 4.25%.
Big yikes.
That substantially changes our projections for the future, right?
That is a pretty dramatic departure from the types of metrics that we see tossed around
online.
Oh, you're going to get 10% per year, because in that sense, your ability to get 10% annualized
returns over the long run might actually have less to do with the economy or the stock
market itself than it does with your own behavior.
And I think the last 12 to 18 months have been a really, really solid test run for many
of us who began investing during a raging bull market, like me, to see how we would react
when the sky began falling because stock market volatility is like turbulence on a plane.
Even though your rational mind knows that the chances of something truly catastrophic
happening are slim to none in the long term, when you are being tossed around like a crumb
in a pringles can at 35,000 feet, your rational mind is not the one that you're using.
That's going to take a backseat to your amygdala's fighter flight response.
And it's really hard to reason through visceral fear.
And hey, I am with you.
I am truly to my core, a neurotic over-preparer who also happens to have a fear of flying,
so I'm nothing if not consistent.
So I like to be conservative in my estimates for that reason.
I use a 7% average return plus 3% inflation for an average 4% annualized return in my financial
independence planner for all of my projections.
That is a tab in the wealth planner, by the way.
And I used to feel like I was being way too pessimistic.
But now I feel like maybe that was a gut instinct that served me well.
I don't know about you, but I would rather assume that I'm going to do worse than average,
so I am pleasantly surprised by over-performance if it happens.
But there are other things that we can learn from this DelBar research, so let's go a little
bit further, because since 1984, 70% of underperformance occurred during only 10 key periods
when investors withdrew their investments during periods of market crises.
So translation, vast majority of underperforming the averages happened during a handful of market
crashes, events where people freaked out, they pulled their money out, and the narrative
was that things were going to be no good, very bad, for a long time to come.
But, and this I found actually more surprising, 80% of the time, if an investor had simply
held onto their money and done nothing, they would have gotten better results just one
year later.
So remember, that doesn't even assume that they were holding the S&P 500 or even another
diversified large cap index fund.
Just that, if they would have held literally whatever they were holding instead of selling
it, they would have been better off 365 days later.
As for the scariest numbers I saw in the report, the 30 year return of the S&P 500 was 9.96%
per year, which is where that 10% average number comes from that you'll hear tossed around,
while the average investor over those 30 years got 5.04%.
Bigger yikes, that halves the average, that most of us personal finance fanatics use in
all of our forward looking projections, though as a note, I will always advocate for diversifying
beyond the S&P 500, including things like small cap value or international funds in your
portfolio, though that is a contentious recommendation, it's not an investment recommendation,
just something that I think can help whether the storm will come back to that in a little
bit.
Let's get tactical.
How do you not lose your money or your mind during these downturns?
So by now we probably understand that two things are true about the best ways to build
wealth.
Number one, owning a diversified set of index funds and number two, holding them for the
long term, aka the boring and basic approach, is probably the best way to build wealth
without making large risky bets for most normal people.
So here's the money with Katie Guide to not blowing your own lead and selling equities
when shit hits the fan.
And yes, it is simple in nature, infomercial voice, just three easy steps.
So number one, you're going to build your portfolio the right way in the first place.
We have seen so much investor euphoria since April 2020 when the market began that inexplicable
rebound.
I guess it wasn't totally inexplicable.
We can cue the money printing montage where the Fed stepped in to help prop up the economy
during the pandemic and thank God they did.
It became easy to forget during that time that stocks do not always go up until January
2022.
When, with every passing day, we watched our games evaporate before our eyes.
But in that bull run, that post pandemic period, people took on more risk because they assumed
the reward was guaranteed.
They kept super lean cash reserves.
And in some cases, that's okay.
If you have multiple sources of income, low expenses, small likelihood of emergencies.
In other words, not a homeowner or a parent, you could probably get away with keeping a
pretty lean safety net, but investing a down payment that you need in 90 days or putting
your entire emergency fund into VTSAX.
That was and is a recipe for, oh shit, the market is dipping.
I need to get that money out now before it dips anymore because I need that money soon.
It stands to reason that your likelihood of pulling money out at the wrong time increases
when you invest money that you should not be putting at risk in the first place.
So beyond keeping the right amount of cash on the sidelines to bolster your needs during
downturns, investing in a diversified mix of index ETFs as opposed to just one or a sampling
of ETFs that have near perfect correlation will also help buoy your portfolio in downtimes
and limit the extent to which you feel like you have to make changes in the moment.
For example, when tech stocks got crushed, so like think Facebook dropping 26% in a single
day and February 2022 after a poor earnings report, it disproportionately impacts those
large cap growth ETFs like those that track the S&P 500 because these cap weighted funds
lean so heavily on the tech sector.
Now that's normally a good thing since these tech companies are profit machines via monetization
of your own precious attention, yay, but it also illustrates how the fate of just a few
companies that are typically impacted by the same market forces, regulation, sentiment
even more or less dictates the fate of an entire fund, which is less yay and more
nay.
If you only own the S&P 500 or the S&P 500 plus cap weighted total stock market funds
and large cap starts getting pounded, you are going to feel that deeply pun intended,
no pun intended.
I don't know.
The MU endos are starting to compound and you're likely going to feel more compelled during
the downturn to diversify or sell than someone who is already diversified.
But much like the best time to buy insurance is before you need it, you are better off
proactively diversifying and then making sure your portfolio is benefited by low-ish correlation.
That's kind of hard to do these days, but if you can, between the things that you own.
So we've done an entire episode on building a diversified portfolio and indices that
are worth considering, so we'll link that in the show notes for you.
And at the end of the day, that's what this is about, navigating your own psychology
and increasing the chances that you're going to hang in there.
I remember during the bleeding that was happening in 2022, there was a period when the small
cap value that I owned was doing really well, despite how poorly the S&P 500 was doing.
So I would log in to my co-pilot, I'd see all the different holdings.
Some would be red, some would be green, and seeing some green in my portfolio allocation
helped me stomach all the red.
Even though some of these funds have done worse overall than the S&P 500 in recent years,
the primary benefit of owning them last year for me was that they were not doing poorly
at the same time.
And that according to my personal investor philosophy, my assumption is that this is going
to lead to overall higher returns in the long run.
Okay, so now that we've gotten proactive, we're going to talk about two psychological strategies
right after this quick break.
Welcome back.
We're moving on to number two.
Remember that you still own the same number of shares.
This is something else that helped me a lot during the 2022 correction era.
Think about it this way.
It is pretty disheartening to conceptualize tossing money into a bucket and then over time
losing dollars in the bucket.
That is scary.
It activates that funky human and behavioral reaction of loss of version where we feel like
we're losing money and we want to stop the pain.
But if you imagine more accurately that you are exchanging that money for a piece of
a company, aka a share, if you remember that you still own the same number of shares
and that the number in your brokerage account with the dollar sign next to it is just the
quick conversion of those shares into what they are worth right this second.
It's I think easier to hang on and alleviate the feeling that you're losing anything.
So when prices start falling, hang attention to your number of shares instead and reminding
yourself that that number is the same can help.
Then you want to focus on getting more of those shares while they're priced lower than
before and that kind of gets to the point that the number of shares is really the only
metric by which you can fairly judge your own progress since the market being significantly
up or down could give you a false sense of success or failure is pretty much outside of
your control.
If you owned 100 shares of VOO in 2021 and now you own 120 shares, it doesn't matter
if the quick shares to cash conversion is lower now, you're still ahead because you own
more shares of it.
Now of course this example does not work for things like meme stocks, but if you believe
in the long term viability of the US stock market as a whole large cap companies as a whole
and those are the indices or the index ETFs that you own, it stands up.
And number three, embrace boredom and inaction.
Now this advice is cliche, but it is popular for good reason.
It becomes more tempting to interfere and get creative when markets are going down.
I feel like, okay, I have to be able to effort my way through this blood bath.
I should be able to identify friends.
I should be able to get ahead of them.
But the effects of missing the best days in the market are well documented and I've talked
about them before on the blog.
So we're going to link a very telling graph.
Please hum Nickelback's photograph softly to yourself now from JP Morgan asset management
analysis that demonstrates the absolute tear cut you would have taken.
What you missed, just the 10 best days in the market, assuming you owned the S&P 500
between 2003 and 2022.
And because this is an audio show, not a visual one, I will describe it to you.
Had you been fully invested over this 20 year timeline, you would have averaged 9.8% per
year when annualized.
If you had missed just the 10 best days over those 20 years, you would have averaged only
5.6% per year, which is pretty in line actually with our Delbar numbers.
And if you're like, yeah, but shouldn't it be relatively easy to not miss the best days,
like if I am pulling my shit out when it is tanking, how likely is it that I would quickly
miss a best day?
Turns out it is not easy at all.
Seven of the 10 best days over those 20 years, seven of them occurred within two weeks
of the 10 worst days.
The second worst day of 2020 was followed the very next day by the second best day of
the year.
In conclusion, it's funny because when I began investing in 2018, I figured all the warnings
about how tempting it would be to sell when things got rocky and like how truly scary
it would feel when things go sideways.
I thought it was all hyperbole and I always was warned in the books I was reading the
podcast I was listening to, hey, there's this phrase, you're going to hear this time.
It's different.
And you know, that's never true, but you're going to hear it.
It's going to feel true.
And anyway, it always rang in my ears is something that only uneducated investors would
fall prey to.
But 2022's crash was truly a, oh my god, this time it might be different experience.
We heard that over and over and over again.
And by all measures, the stock market right now does not make literally any sense if
you look at the world around it.
Someone who pulled out expecting things to tank in 2023 was not stupid or ill informed.
They were just missing the fundamental truth of the stock market, which is that it can
stay irrational far longer than you can stay solvent.
And even as someone who thinks about personal finance constantly, I know these tropes
like the back of my hand, I felt the fear.
That fear was real, doubt seeped in and I felt the temptation to pull back and just stop
adding more to the incineration that was happening inside my brokerage account.
But as I told myself during this time, in order to limit your chances of getting nervous
and blowing it, try to number one, have the proper amount of cash set aside in the
first place for your personal comfort, your expected purchases and then diversify your
investment funds proactively.
Number two, remind yourself with excessive fervor that you still own the same number of shares
when things are going down.
In fact, if you need to stop tracking your net worth and dollars and start tracking in
shares owned, try it.
And number three, tattoo these charts about missing the 10 best days in the market to the
inside of your arm and then reference it frequently.
We don't do this literally, but if you do, let me know, send me an email.
Realistically, when we project 10% average returns with 3% inflation for our portfolios
or a 7% average return, if you're trying to control for inflation, though you'll technically
end up with like slightly different numbers outcomes doing it that way, we have to remember
that it is not outrageous to claim that our behavior determines the likelihood that we're
going to get that return more than the market itself does.
So if you want to use 10% returns, remember, you sacrifice your opportunity to earn those
the moment that you start trying to hop in and out.
If that is the strategy, create future projections using average 5% returns instead, as that's
what the data tells us is more likely.
And bonus, it'll hopefully serve as a deterrent for trying to time the market.
Alright, y'all, that is all for this week.
I will see you next week, same time, same place on The Money with Katie Show.
Our show is a production of Morning Brew and is produced by Henna Valais and me, Katie
Aditasan, with our audio engineering and sound design from Nick Torres.
Devon Emory is our chief content officer and additional fact checking coms from Kate
Brent.