In 2013, the market performed very well for many investors. However, there are some people who feel as if they missed out on opportunities since their portfolio return didn’t keep up with domestic stocks. Some investors, with a balanced portfolio that includes a long-term perspective, feel as if their portfolio could have performed better.

This feeling is reinforced by industry news media who often seem to highlight the strongest gains of 2013 while frequently ignoring the potential risks. If you have a long-term investment strategy and feel as if you missed out in 2013, I’d like to offer an alternative perspective.

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"Financial planning is the cornerstone of wealth creation. This is why I am so committed to helping my clients build the right financial plan, tailored to their unique family."

 

Market Timing Investor versus Time In Market Investor

There is an old saying in the financial services industry, “consistent results don’t occur from timing the market, rather from time in the market.” This speaks of primarily two kinds of investors, the Market Timer and the Long-term Investor. These two investor profiles could not be more different in how they approach their wealth creation goals.

The Market Timing Investor buys and sells financial products based on short-term market movements. Time in the market investors, or what we might also call long-term strategy investors, buy and hold based on a sound long-term investment strategy.

The Market Timer watches CNBC, reads Money magazine and then makes investment choices based on emotion. This often equates to buying when they feel good and selling when their stomach hurts – ultimately buying high and selling low (not good for investment results).

Timing is usually an emotional decision, not a rational decision. Investors who buy into this approach are trying to get rich quick by loading up on individual stocks and hoping for positive results. This investor often has a stock ticker in front of them for many hours per day and constantly watches market changes.

The long-term investor understands that investing early and often into a strategic long-term plan will result in reasonable risk-adjusted returns over the long-haul. This investor is guided more by their long-term goals than by short-term market movements. In order to achieve life goals, this investor knows that they have to control risk, first and foremost. This investor rarely watches micro-market changes and instead focuses their efforts on their work, loved ones and personal life.

 

The superiority of the long-term perspective

The long-term investment perspective is superior because it provides better returns over the long-haul and it delivers greater peace-of-mind to investors who work hard for their money. How does the long-term perspective deliver greater returns over time?

The primary reason that long-term investors outperform short-term return chasers is because the long-term investor still participates in bull markets but loses far less in bear markets. The outperformance happens on the downside, not the upside. This is what investment professional call upside and downside capture.

For example, a certain balanced portfolio’s objectives could be 80% upside capture and 50% downside capture. The result is that this portfolio still realizes solid gains when the market is on an up-swing, but loses far less when the market takes a nose dive. What would it mean to you if the market was down 30% but your portfolio was only down 10%? This describes significant outperformance in a draw-down year.

What most people underestimate is that if your portfolio drops 50%, you have to realize 100% rate of return before you are back to break-even. At a 7% annualized return, it could take as many as ten years to recover.

If you doubt this perspective, please consider the research below from Morningstar about short-term versus long-term investors. 
 

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Exhibit 1

The image illustrates the divergence in total return and investor return for a mutual fund selected from Morningstar’s open-end fund database. The fund’s 10-year total return was 10.6%, but its 10-year investor return was –16.3%; quite a difference. The fund’s net cash flow tells the story of the discrepancy. Investors piled into the fund during its run-up, with most inflows occurring near the investment’s peak. Investors then fled as the fund’s returns plummeted, with most outflows occurring near the investment’s bottom. In fact, investors were still leaving the fund as it rebounded and consequently were not around to recoup some of their losses.

Morningstar investor returns measure how the typical investor in that fund fared over time, incorporating the impact of cash inflows and outflows from purchases and sales. It is not one specific investor’s experience, but rather a measure of the return earned collectively by all the investors in the fund. Total return measures the percentage change in price for a fund, assuming the investor buys and holds the fund over the entire time period, reinvests distributions, and does not make any additional purchases or sales. Investor returns are not a substitute for total returns but can be used in combination with them.

 

Exhibit 2

Investors who attempt to time the market run the risk of missing periods of exceptional returns. This can lead to significant adverse effects on the ending value of a portfolio.

The image illustrates the value of a $100,000 investment in the stock market during the period 2007–2012, which included the global financial crisis and the recovery that followed. The value of the investment dropped to $54,381 by February 2009 (the trough date), following a severe market decline. If an investor remained invested in the stock market over the next 46 months, however, the ending value of the investment would be $114,561.

If the same investor exited the market at the bottom to invest in cash for a year and then reinvest in the market, the ending value of the investment would be $74,640. An all-cash investment at the bottom of the market would have yielded only $54,547. The continuous stock-market investment recovered its initial value over the next three years, and provided a higher ending value than the other two strategies. While all recoveries may not yield the same results, investors are well advised to stick with a long-term approach to investing.

About the data

Recession data is from National Bureau of Economic Research (NBER). The market is represented by the Standard & Poor’s 500®, which is an unmanaged group of securities and considered to be representative of the U.S. stock market in general. Cash is represented by the 30-day U.S. Treasury bill. An investment cannot be made directly in an index. The data assumes reinvestment of income and does not account for taxes or transaction costs.

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As these slides show, the key to realizing reasonable levels of risk-adjusted returns is a diversified portfolio which is rebalanced to strategic targets over time. This approach requires the support of a disciplined and seasoned investment professional who intimately understands your investment goals, personal situation and time horizon.

 

How does the long-term perspective deliver greater peace of mind?

Most long-term investors value peace-of-mind over risky returns. Those who chase short-term returns typically don’t have an investment plan. Chasing returns is glorified gambling. Long-term investors, on the other hand, have a plan and practice the discipline necessary to stick to that plan over time. The long-term investor seeks to maximize returns for the level of risk taken.

This gives peace of mind to people who are wondering how their hard-earned money is invested. They know the expected return for the portfolio over the long-haul and feel good that when they save money for investments, they know exactly where that money is going.

 

Why you invest in the first place

At Whitnell, most of our clients view their wealth as the means by which they provide for the ones they love and the charities about which they are passionate. This means that their investment goals are usually tied to their desire to provide a certain lifestyle and standard of living for themselves and their family – as they envision this scenario in the future. Most of our clients’ wealth creation goals are based on their future family, the relationships they believe will be most important to them over time.

Of course, there is risk in investing. But how much risk are you willing to take when what you are risking is your ability to care for the ones you love the way you want to care for them over time? There is no certainty in investing. But creating a balanced portfolio with a long-term perspective significantly increases probabilities that you and your loved ones will reach your long-term goals.

 

Next steps

Most of our clients prefer a balanced portfolio with a long-term perspective because they want to sleep better at night and know that they’ve taken the best possible reasonable steps to achieve their financial goals. Do you understand what type of risk is inside your portfolio? What are the return expectations for your investments? Are these goals aligned with your personal goals? If not, or if you don’t know, please reach out to me and let’s have a conversation.

 

Disclaimers:

You should not assume that any discussion or information contained in this article serves as the receipt of, or as a substitute for, personalized financial planning and/or personalized investment advice from Whitnell & Co. To the extent that the reader has any questions regarding the applicability of any specific issue discussed above to his or her individual situation, he/she is encouraged to consult with the professional adviser of his/her choosing.

Any hypothetical examples included in this article are for illustrative purposes only. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those shown.