I agree. There is usually a huge difference between an investor’s return and the return of his investments. This is a constant issue for use with our clients, since people are more likely to invest after a big up year and then not invest when the market is down and cheap.

I’m not aware of a complete enough study, but the Dalbar study is a good indicator. It shows that investors in equity mutual funds earn on average about 1/3 of the return OF THE INVESTMENTS THEY OWN.

So, if you pick an average fund (not hard) and just hold it, you will have triple the return of most investors!

The reason is that investors continually buy what is currently “doing well” and sell it when it is not. In other words, investors continually buy high and sell low.

I’m not aware of a study like that with stocks, except for one study of hundreds of thousands of discount brokerage accounts that showed that the vast majority of trades are dumb. In the majority of trades, the investment sold subsequently out-performed the stock bought.

I recall some studies from the 1990s bull market that showed that most amateur investors lost money over the long term in a bull market, but I don’t remember the details now.

With indexes, ETFs, dividend stocks, etc. the general rule of thumb is that the more you trade, the worse you do. There are no specific studies we are aware of, but we are quite sure that investors in broad indexes or dividend stocks that hold for a long time will probably do okay, but investors in ETFs are constantly tempted to trade and likely will do very badly.

Day-traders and market timers are unlikely to even show a profit after decades of investing in bull markets.

In general, I’m sure amateur investors in stocks do worse than those in mutual funds, because they also tend to trade more often. The Dalbar study shows that even with mutual funds, the average investor loses 6-7%/year because of trading, which is about three times the typical MER. With individual stocks for most investors, I’m sure this loss from trading is quite a bit more.

One other study showed the average investor made 20% lower than they claimed. The average investor claimed to have made 15%/year, while the actually lost 5%/year.

As the old saying goes: “Your portfolio is like a bar of soap. Every time you touch it, it gets smaller.”

I agree that most people would be better with a forced government pension program, but I certainly would not want one for myself.

Ed

To me that is more telling – it is one thing to state that the individual indices returned X% but it is quite another to coldly look an investor in the eye and tell them that if they are average they might only earn half of that X%.

The challenges most people have with diverting sufficient income to investing, selecting an investment style and investments that are appropriate and yet change as their circumstances do must be fraught with peril. But to do nothing could be even worse.

I think that if the government were to offer a supplementary pension plan that the vast majority of Canadians would be well served utilizing such an option.

A lot has happened in 140 years. We have not had a black President, but there have been thousands of bank failures, World Wars, depression, huge bull and bear markets, shocking high and low inflation, etc. If something did not happen in the last 140 years, it would be hard to predict.

Of course, anything COULD happen, but 140 years of data gives us a very good idea of what is normal and what to expect in almost any market.

The purpose of the article is to show how resilient the stock market has been in all kinds of conditions and that risks, especially long term, are a lot lower than most people believe.

The reason that the US and Canada have not had 20 years of a big negative like Japan is that they have never had a boom like Japan. The Nikkei was up from about 200 in 1970 to 40,000 in 1989 – and that excludes dividends.

The return of the Nikkei from 1970 to now is about the same as the S&P or TSX – about 10%/year.

Periods of huge bull markets or bubbles have historically been followed by periods of underperformance to return the total return to a more normal return. We believe that is the main reason the S&P500 has made nothing in the last decade – a return to normal after the tech bubble ending in 1999.

Some writers such as Ken Fisher (”The Only 3 Questions You Need to Ask”) and Dimson, March & Staunton (”Triumph of the Optimists”) show that over the long term, it seems nearly all indexes have similar returns. Fisher argues that riskier indexes, such as the NASDAQ, have about the same return long term as the core indexes. The returns of stock markets of 16 major countries from 1900-2000 range between 7.6% and 12.5%/year, with 6 being between 11.6-12.5%/year and 8 being between 8.9-10.1%/year.

There were some huge crashes and booms, but they were followed by periods to make it up. Hyper-inflation from 1910-20 in some countries was made up by the boom of the 1920s. The Great Depression of the 1930s in some countries was made up in the 1940s. Some countries lost WWII in the 1940s and had massive crashes but made them up in the 1950s. And Japan’s huge asset bubble of the 1970s-80s was offset by the big decline in the 1990-2000s.

I’m not aware of any example of a major country where a decade-long major market decline was not essentially made up the previous or following decade (or 2 in Japans case), although it did happen in quite a few countries’ government bonds.

If we ever have a 20-year bear like Japan, it will almost definitely either be after a bubble many times larger than the tech bubble or before an unbelievably big recovery.

Ed

I’ve read quite a few articles subtracting multiple factors from returns, but I don’t know what to learn from them. I can understand excluding inflation to see the purchasing power effect, but why exclude dividends?

Try the same thing with bonds – subtract the interest payment and inflation and what happens – oh,my god, they lost money every single year! They still have not recovered from the decline in 1800.

There is no knowledge of any value in this, though.

Ed

Good point, but the recoveries we show from market declines all take into account the right math – that you need a somewhat larger gain to make up for a loss.

Ed

I showed the down periods with and without the 1930s, since that period has dominated all negative stats. Many people (us included) believe that the 1930s period would not happen today, because it was made far worse by government actions.

The government did not stand behind the banks, which resulted in a run on the banks, and tried to balance its books by jacking up taxes and cutting expenses.

I’ve read some articles that claim that 2008 would have been a 1929-32 type crash if the government had responded the same.

Economists may not have taught us much, but that is one thing governments have learned.

Ed

Of course, anything could happen, but if it has not happened in 140 years, then it is probably very unlikely.

The largest multi-year declines (excluding the 1930s) are similar to the largest single year declines – and both are less than most people think. The worst year since 1871 was 2008 at -37% and the worst multi-year declines were -38% (tie between 1973-4 and 2000-2).But losses over 50% have not happened in calendar years.

Ed

I agree completely. investing with the investment All-Stars and studying them is the way to success. How did you “stand on the shoulders of giants” with your portfolio?

Ed

Thanks for your comments. If you plan to pick your own stocks, you should definitely get educated first. It is far more complex than it looks.

Ed

Till then,

Jean

You concluded the first point with “Therefore, assuming the future is like the last 140 years…” That’s a pretty big assumption based only on 140 years or data. I mean, U.S. didn’t have a black president for a lot more than 140 years before, but Obama was nevertheless elected last year. Blindly projecting the past into the future is a mental fallacy that all investors need to avoid, that’s how you go broke. After all, Lehman brother didn’t go bankrupt for 158 years, and we all know what happened…

Your second point is even more concerning. You took absolute growth to be the real growth. If you take inflation into account, average inflation for 1929-1949 and 1966-1982 are about 2.1 and 6.9% respectively. That means your real return after inflation would be 1.6% and -0.2%. I would hardly call that growth. For 1929-49, you would have faired approximately the same if you had put your money into AAA bonds and collected interest rate, but you would have taken on a lot less risk. For 1966-82, however, you would have gotten ~8.6% return if you had put money into AAA bonds, so you would have been better off.

It interesting that you mentioned Japan in your article. It is the best prove that market doesn’t alway recover quickly. Nikkei 225 hit a high in 1990 and has pretty much been range bound ever since. It’s current closing level is basically the same as 2004, and about half the value of 1994. Many of the economic problems persists and it has been in stagflation for the last 20 years. This is the second largest single country economy we are talking about, not some country in Africa with no stable currency.

You article demonstrate the exactly how one should not think about money and markets. I hope you are more diligent and thorough when it comes to picking your investments than writing your articles…

http://bit.ly/7aQ5n7

I could find 4 cases since 1871 where declines greater than 60% have occurred. The first started in 1906 where it took greater than 14 years to reach a real low. The second is the well known one commencing in 1929. The third started in 1968 and took over 13 years to reach the real bottom. The final started in 2000.

I’d appreciate any comments as it shows that excluding dividends real declines can last a very long term.

Link is here
http://retirementinvestingtoday.blogspot.com/2010/01/history-of-severe-real-s-500-stock-bear.html

As for the posts, I always love reading them, and some great ‘opinions’ come out. Keep it up; this one’s good food for thought, as well as the comments above.