Chart & Video: Periodic Table of Investment Returns
I keep a copy of this chart on my desk as a steady reminder of the wide dispersion in annual returns between asset classes from 1999-2018. When building an asset allocation (i.e. the mix of stocks, bonds, real estate, & cash), we can’t know which assets are going to perform great (or poorly) in advance. Some managers will claim the ability to do so, but they’re either naïve or deceptive…. No one can consistently and accurately jump in and out of any market.
Note: Some managers can have success for a little while, at which point they make the business decision to get really loud about their recent wins. They use this success streak to attract a bunch of new clients/investors and then try their best to hang onto them….Again, the success rarely persists.
This chart also serves as a good reminder that the best and worst performing asset classes are rarely the same for many consecutive years --this is important, as it highlights the merits of diversification. Being diversified means we won’t ever get things exactly right, but we also should be able to avoid getting them exactly wrong.
Take a look at the best performing asset class of 2018…..it was Cash (+1.87%)!
Most financial plans are made around some annual rate of return (like 5%,6%,7%,8% or 9%), and books, radio shows, TV programs, podcasts, etc. will tout returns like 10-12% per year when making assumptions. Clearly that wasn’t the case for an investor who bought any asset class at the beginning of 2018.
Here’s the reality: Timing does matter, but we can’t time the market, and we also can’t let the fear of having poor timing prevent us from making decisions. Over the long term, the impact of good or bad market timing decisions should be lessened by the effects of compounding.
Below is a link to a PDF of the chart, as well as a quick video to walk you through it.
Photo: The World’s Worst Traffic Jam
Have you ever been on the freeway and merged over to the “fast lane” only to find that the lanes you just left are now moving faster than this supposed ‘fast’ lane? It happens to the best of us. As it turns out, traffic is a great metaphor for investing and it’s a nice segue from the discussion of asset class returns above. If we’re constantly trying to duck in/out of the fastest and slowest lanes, we often find ourselves not much further ahead over time. As it pertains to investing, if we’re constantly trying to duck in/out of the best asset classes, our probability of this working in our favor is low.
Sometimes it’s best to just stay in your current lane…. Remember, you’re not stuck in traffic, youare traffic.
Article: I Inherited Money. Should I Invest a Large Sum at Once? Or Space It Out?
This article explores Dollar Cost Averaging (DCA), which is a method for managing risk while investing capital over time. The principle of DCA is fairly simple: rather than dumping your entire savings into an investment all-at-once, an investor can mitigate the risk of poor market-timing by investing a fixed, smaller sum repeatedly over time across many different market prices.
Most of my recommendations of DCA comes under two circumstances: (1) if you’re an investor who’s been accustomed to taking very little risk and we therefore must adopt risk slowly over time, and (2) when you’re shifting your human capital (earnings) into financial capital (portfolio wealth). If you’re an earner, then the recommendation of partaking in some form of DCA is almost a given –after all, your regular 401(k) contributions are being made on a DCA schedule. However, when you have a lump sum to invest (maybe it’s cash sitting in the bank), the ‘best’ path is a bit more muddied.
Markets tend to go up more than they go down. This article claims that, historically, about 70% of the time an initial lump sum investment yielded better 1 year returns than dollar-cost-averaging over that 12 month period. However, returns aren’t everything –if you’re a risk averse investor who’s building up their risk tolerance, having that extra cash in the bank over the course of that year may allow you to sleep a little better at night. We don’t think it’s a waste of money to spend years paying auto insurance premiums without getting in an accident; those premiums addressed a risk. Similarly, DCA can address a risk.
Here are some principles from the article to help you understand the right situation for DCA:
1) DCA only works when the market drops and a purchase is made. Behaviorally, it is difficult to buy after declines and this is very hard to execute; do anything you can to make this purchase automatic and objective.
2) DCA of a lump sum reserve will eventually cause that entire lump sum to be invested. Eventually the risk you’d been addressing by using DCA in the first place (the risk of investment volatility) is now fully present. During the DCA phase, investors need to be doing everything possible to build the risk tolerance necessary to maintain the strategy that will ultimately represent their portfolio after all of the capital is invested. Aside from shifting your earnings into your portfolio, DCA should be a means to an end.
Simply put, DCA of a lump sum can be a great, disciplined way to hedge regret. It can be far better to risk achieving lower returns in an upward market if the alternative is to perform the financial equivalent of tossing someone in the deep end of the pool when they’re learning to swim. That said, if there’s no behavioral accommodations that must be made, then historical returns begin to question the viability of DCA strategies.
Link to Article:
That’s it for this week,