{"id":5588,"date":"2016-06-24T14:24:30","date_gmt":"2016-06-24T21:24:30","guid":{"rendered":"http:\/\/canary.kcprod.info/blog\/?p=5588"},"modified":"2022-01-11T17:12:31","modified_gmt":"2022-01-12T01:12:31","slug":"brexit-and-investing","status":"publish","type":"post","link":"https:\/\/canary.kcprod.info/blog\/brexit-and-investing\/","title":{"rendered":"What Brexit Can Teach Us About Investing"},"content":{"rendered":"

This post is based on an original post<\/a> by Andy Rachleff, published on the Wealthfront blog on July 22, 2015. It has been updated based on the recent referendum in the United Kingdom.<\/em><\/p>\n

Over the last few weeks, the financial news has been filled with predictions of what might occur based on the recent referendum in the United Kingdom. Over the last 24 hours, the financial news cycle has been escalated to a fever pitch based on the results. Overnight market futures dropped significantly in several major markets, including hitting the 5% limit for overnight S&P 500 market futures. The British Pound dropped more than 10%. The Prime Minister has resigned. The FTSE 100 declined 3.15% today, but finished the week up 1.99%.  Markets around the world have dropped, recovered and dropped again as analysts and traders work feverishly to find an angle in a changing political environment.<\/p>\n

What should an investor do?<\/p>\n

In a word: Nothing<\/strong>.<\/p>\n

If there\u2019s anything that the day-by-day machinations of the market teach us, it is that slow and steady wins the race.<\/p>\n

The Incredible Consistency of Stock Returns<\/strong><\/h2>\n

Investors have long known that staying the course is one of the most important things to do. Some of the best research on this topic comes from University of Pennsylvania professor Jeremy Siegel. In his New York Times bestselling book, Stocks for the Long Run, <\/em>Siegel looked at the performance of equities from 1802 through 1997, the year the book was first published.<\/p>\n

His findings were astonishing: Despite the day-to-day volatility that we all feel, the actual long-run returns of stocks are remarkably consistent.<\/p>\n

Here\u2019s how he summarized his findings:<\/p>\n

\"longrun\"<\/a><\/p>\n

\u201cDespite extraordinary changes in the economic, social, and political environment over the past two centuries, stocks have yielded between 6.6 and 7.2 percent per year after inflation in all major subperiods. The wiggles on the stock return line represent the bull and bear markets that equities have suffered throughout history. The long-term perspective radically changes one\u2019s view of the risk of stocks. The short-term fluctuations in market, which loom so large to investors, have little to do with the long-term accumulation of wealth.<\/em><\/p>\n

His last line bears repeating: The short-term fluctuations in market, which loom so large to investors, have little to do with the long-term accumulation of wealth<\/em>.<\/p>\n

Siegel found that almost no matter what period you looked at, stocks delivered about 7% after inflation. The Civil War, World War I, World War II, even the Great Depression (marked by the second black vertical line) were hiccups compared to the overall trend.<\/p>\n

The pattern repeats in other countries, including those that have experienced catastrophic collapses. World War II, for example, sheared 90% off the value of German equities \u2026 but German stocks completely rebounded by 1958, rising 30% per year on average from 1948 to 1960. They went on from there to new highs. Averaged out over the long haul, their return is a consistent 6.6% real return \u2026 a figure that continues through this day.<\/p>\n

The same is true for Japan, the UK, and all other markets that Siegel has studied; in the short-run, volatility, but in the long run, profits.<\/p>\n

Can\u2019t We Just Side-Step the Disaster Spots?<\/strong><\/h2>\n

Of course, the best possible outcome would be to steer clear of pullbacks, selling when markets are about to collapse and buying when they start to recover. This is the marketing pitch used by virtually every active manager in the world, and it is intuitively compelling.<\/p>\n

\u201cThe European Union has been a disaster for years,\u201d <\/em>you can\u2019t help but think. \u201cSurely, if I had been paying attention, I would have sold and avoided the recent turmoil.\u201d<\/em><\/p>\n

\u201cThe polls were showing that this vote might happen. Why wasn\u2019t I prepared?\u201d<\/em><\/p>\n

Unfortunately, the data shows that even high-paid professionals are bad at sidestepping these pullbacks, and everyday investors are worse.<\/p>\n

As mentioned repeatedly on this blog, every piece of significant data shows that the vast majority of active mutual fund managers underperform the market over any meaningful period of time. Despite all their high-paid analysts and fancy data services, they can\u2019t beat a broad-based index.<\/p>\n

But the dirty little secret is, as bad as professional money managers are at beating the market, retail investors \u2013 on average \u2013 do worse.<\/p>\n

In a major study published in February 2015<\/a>, Morningstar looked at the difference between the average return of mutual funds and the actual returns that investors enjoyed. The data is brutal: While the average U.S. equity mutual fund returned 8.18% for the decade ending December 31, 2013, the average dollar invested in U.S. equity funds returned just 6.52%. For international equity funds, the situation was worse: an 8.77% return for the average fund, but a 5.76% return for investors.<\/p>\n

\"morningstar\"<\/a><\/p>\n

John Rekenthaler, the vice president of research at Morningstar, explained what was happening in Barron\u2019s last year. \u201cThe problem,\u201d the magazine wrote, summarizing his comments, \u201cis that investors tend to get in and out of an asset class at the wrong time.\u201d<\/p>\n

In other words, we tend to buy high and sell low. The problem is worse in the more volatile asset classes, ostensibly because we\u2019re more likely to panic.<\/p>\n

[It\u2019s not just Morningstar. DALBAR conducts an annual study<\/a> that looks at the same effect over rolling twenty-year periods. Its last finding shows that investors underperformed the market by 4.2% per year over the past twenty years.]<\/p>\n

Don<\/strong>\u2019t Buy What They\u2019re Selling<\/strong><\/h2>\n

The reason we don\u2019t hear much about the power of long-term investing \u2013 and the truth about the futility of trading \u2013 is that long-term investing is boring and it\u2019s cheap. The financial media thrives by encouraging you to panic, and large parts of the financial industry make money only when you act. Big moves sell newspapers, and high trading activity means commissions for online brokers. The only people who don\u2019t profit from that activity are investors themselves, because as it turns out, we can\u2019t predict the future.<\/p>\n

Even as we finalize this post, markets are stabilizing, politicians and economists are projecting that the ramifications of this vote will likely play out over the next few years. Markets may fall next week, or they may recover. No one can be sure for certain, but the overwhelming evidence is that most of the people who try to trade based on their predictions will underperform those who stick to a prudent, low-cost and diversified long term strategy.<\/p>\n

It\u2019s hard to stare down a significant market correction and stick to your plan. When the US government shut down in September 2013 during the budget showdown, we saw a large number of clients refrain from continuing to add deposits. They paid handsomely for that mistake by missing out on the rebound. If you invest regularly, harvest your losses and rebalance your portfolio, you\u2019ll end up benefiting from market corrections in multiple ways.<\/p>\n

It won\u2019t be easy. But over the long haul, it will likely pay off.<\/p>\n

For more on this topic please read:<\/p>\n