Ray Link’s recent guest blog was one of our most popular entries! And today I am pleased to present a guest opinion from another financial expert with a slightly different perspective. Doug Johanson is one of the Northwest’s leading financial managers, and I have always known him to take a sensible long-term perspective towards the market. He advocates discipline in investing and stresses a long-term approach towards the market.
Of course, right now investors are finding their resolve (and nerves) a bit tested. As I write this the Dow is off another 250 points, diving into areas I frankly did not think it would hit. Last night as I drove home I listened to a very pessimistic George Soros on NPR essentially advise investors to take their money and bury it in the back yard to avoid what he believes is the coming really big meltdown. But sometimes the Warrior finds opportunity when other people run in terror, and I personally find myself conflicted. Though I am not a market timer, common sense and a historical perspective towards the market is giving me a buy sign, yet these are weird and wild times. Filling your tank might require taking out a home equity loan (if only you could get one), and the once venerable General Motors has a market cap smaller than Hooters. So, lets listen to Doug’s calm and rational advice, and hope he is right.
The Importance of Discipline
by Doug Johanson
While I agree with Ray’s general premise and his analysis, that stocks can go long periods of time underperforming cash, this could easily lead the casual reader to form a harmful conclusion – primarily that stocks should be avoided.
As investors in the world’s financial markets, we all need to be acutely aware that the higher the return of a given asset, the higher the risk (or fluctuation) that should be expected in the short run. You’ll see in the chart below that during the last 83 years stock returns outpaced cash (T-bills) by nearly seven percent annualized. However, there were still three time periods of nine years or longer, including the present, during which stocks unperformed cash. After each one of these periods, you’ll notice the significant and prolonged outperformance of stocks. What is an investor to conclude from this? We have concluded that patience and discipline are absolutely essential keys to successful investing – along with the proper asset allocation (diversification) and a focus on driving down the costs and taxes associated with investing.
While Ray accurately states that most investors should “reduce equity exposure well in advance of retirement”, let’s not forget that “retirement” for most people occurs far in advance of their eventual death which, for planning purposes, may not happen for another 30+ years. A person’s time horizon and subsequent tolerance for risk should not be defined by their retirement, but by their life expectancy. There are no 20-year time periods, much less 30-year time periods, during which stocks underperformed cash. In fact, since 1926, stocks have lost money only 10% of the time over five years and never over 15 years. That type of fluctuation seems like a small price to pay for the superior expected long term return of stocks relative to bonds and cash.
Finally, let’s not forget about what is even a greater risk for most people than volatility risk, the risk of inflation eroding their standard of living. Inflation refers to the price appreciation of the basket of goods and services we all purchase and use as consumers. Even moderate amounts of inflation have a powerful effect, in that 3% annualized inflation will double prices in 24 years. A person retiring at age 55 will have to pay twice as much to shop, eat, travel and stay healthy when they are 79. Remember, cash, and even bonds for that matter, basically generate returns in line with inflation. A portfolio invested too heavily in cash and bonds could easily result in a person not being able to maintain their standard of living.
If one chooses to view volatility relative to inflation, the story becomes much different. According to Vanguard, since 1926, a cash portfolio, after inflation, experienced as high a percentage of years with negative returns (35%) as an all-stock portfolio (also 35%) and just slightly less than a bond portfolio (38%). Of course, the magnitude of both negative and positive returns is greater with stocks than bonds or cash.
When financial markets turn turbulent, as they are now, the stock market is a scary place and cash investments seem like a terrific alternative. There is also no question ten years can seem like an eternity. The problem with too much of a “play it safe” approach is that the returns may be too low to meet your long-term financial goals, such as a comfortable retirement.
About the author: Doug Johanson is a Principal and the Chief Investment Officer for Vista Capital Partners, a Portland, Oregon-based registered investment advisory firm. Doug has been managing individual and institutional portfolios for the past fifteen years. A CFA charter holder, Doug earned his Bachelor of Science degree in Finance (magna cum laude) from the University of Oregon. Doug is past-President of the Portland Society of Financial Analysts.