Aug 25, 2008

caveat emptor

Since I work in the investment industry I generally don't like to offer investment advice. But I'll offer up a couple here because I think they are important ones. And based on conversations with a few friends over the last few months, counter-intuitive ones.

Let's go to the charts:

This is a plot of the Dow Jones Industrial Average from 1930 to today on a logarithmic plot. The plot is slightly deceiving because it does not include dividends in the performance. Dividends add about 2.5% to returns. Since inflation is also about 2.5% on average you can view this as a constant dollar plot which in some ways is more useful. I've marked up the plot with lines marking 4 regimes.
  1. A steady climb to about 1,000 until 1965
  2. A flat region until about 1982
  3. A steady climb to about 11,000 until 1999
  4. A flat region continuing today
Point 1: Investing for 20 years does not guarantee good returns in the stock market as evidenced by the second regime. Conventional wisdom has it that 20 years is a good benchmark. But really 30-40 years are necessary to guarantee decent performance. This goes back to a point of conventional wisdom that is useful; the earlier you start investing the better off you are. I suspect the current regime of non-performance will continue for at least another 10 years. There are very few catalysts in my mind for outperformance and we've just come out of a period of credit, housing, and technology bubbles which implies overcapacity. It will take a long time to work through that overcapacity.

Point 2: The second point I'll make in the form of a question. What period would you want to be investing in? Most people would say 1 or 3. The best time to invest is actually 2 and 4. The way to see this is to turn things around. let's say you were investing primarily in the regimes where stocks were advancing. By the time you hit retirement you would be in a period of flat performance. So each day you are pulling money out of your retirement account, that retirement account is getting smaller and smaller. I'm sure that leads to an inordinate amount of stress. Imagine people who retired in 1999 and have seen their investments go nowhere while they have been pulling money out. I think that's a scary proposition.

It is far better to be putting money in during the flat regimes like we are in now. You have a better chance of living off those investments while they are increasing in value.

Point 3: Can you spot Black Monday on the chart? October 19, 1987? It's pretty hard right? That was a major day. Even though I was just out of high school I remember that day vividly. Now it is a small blip on the screen. That's why you should ignore market movements, especially big ones, that are currently happening.

Uberpoint: The primary piece of wisdom from these observations is that you should consider the current state of the stock market a godsend for those who have some time to put their money to work. You should be putting every dime you can into the market right now so you maximize your length of time invested and also maximize the amount of money you can invest while we are in this flat regime. And don't get head-faked by big movements up or down.

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