Five Truths Every Investor Needs to Know: #1

global tradeMy Comments: This is the first of five “truths” that appear in a brochure published recently by Invesco, a global wealth management company with offices in over 20 countries, serving clients in more than 150 countries.

As you consider your wealth, or lack of it, these ideas may serve to keep you grounded and making better decisions. As someone who has made both good personal decisions, and bad ones, this might prove helpful to some of you.

Also, my wife and I will be traveling for the next several days. Those few of you who follow these posts, please know I’ll be ‘retired’ until May 5th at the earliest.

#1 – The Truth About Gains and Losses

Myth: My portfolio will be in fine shape if it has more up years than down years.

You may have heard that because the stock market’s good years have far outnumbered its bad years, equities are a good play.

It’s true that from 1926 to 2014, the S&P 500 Index has posted 65 positive years and only  24 negative years. If your investment portfolio were scored by “match-play” rules, like tennis, that would be good news because you’d win if up years outnumbered down years. How well your portfolio performed in each of those years wouldn’t matter.

Truth: The magnitude of gains and losses counts more than their frequency.

In reality, portfolios are scored under “stroke-play” rules — like golf. In stroke play, it doesn’t matter how many individual holes you win, it’s the total score that counts. Mistakes on just a hole or two can ruin an otherwise well-played game. Likewise, in investing, it may take just one or two exceptionally bad years to push you off the investment path to victory.

As the decade from 2000 to 2009 showed us, it’s possible for the market to have more up years than down years, yet still lose money on average. This decade included six up years and four down years, yet resulted in a total return of -9.10%.

Scorecard

Action: Understand the market’s scoring system and design an investment strategy accordingly.

Now that you know how the market keeps score, ask yourself this: What does it mean to achieve victory in investing? Does it mean my portfolio made money during the years I invested? If that’s the measuring stick, then victory is easy to achieve, according to the following chart. All you’d have to do is invest in the stock market for 10 years — nothing else. Historically, that strategy has yielded positive returns 95% of the time. But, of course, it’s not that simple.Scratching

The investment plan you and your financial advisor map out as a path to your goals assumes a certain level of contributions and an average rate of return over an investment lifetime — typically a return of 10% or more from an investor’s equity allocation for a plan to be on target. Simply scoring positive returns doesn’t mean you’ll reach your goals.

The true victory in investing is achieving your financial objectives — retirement, home ownership,a child’s college education — not merely making money over your years of investing. If your portfolio doesn’t make enough to reach your goals, then you haven’t really won. And, as we’ve seen, just one or two exceptionally bad years can throw you off course. That’s why you need an intentional approach to investing with an asset allocation strategy that seeks to balance downside protection and upside participation instead of one that chases returns at the expense of risk management.

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