“History doesn’t repeat itself, but it rhymes,” according to a popular Wall Street saying that is often (mis)attributed to Mark Twain. No matter the source, it makes good copy! Looking beyond its cleverness, the saying does make sense. History never exactly repeats itself but closely studying financial market history can help us avoid making big mistakes in the future.
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Thanks to Ibbotson Associates, a Morningstar company, we have reliable data on the historical returns of several major asset classes dating back to 1926.
Going back that far covers the Great Depression as well as numerous bull and bear markets, the stock market crash of 1987, and the Great Recession of 2007 – 2009.
In today’s show, we discuss financial market history and the lessons we can learn from studying the historical returns of common types of investments. Even though past performance is no guarantee of future results, having a good understanding of the past adds perspective and context to what’s happening today.
And speaking of what’s happening today, the stock market is off to a rough start in 2016. Concerns about declines in corporate earnings, slowing growth in China, volatile oil prices, and potential increases in interest rates have all been weighing on the markets. Today’s show is particularly timely because we take a long-term market history perspective and show how short-term noise (like we’re experiencing today) is often necessary to set the stage for longer-term growth.
Join us as we learn how to benefit from market history so we don’t keep repeating costly investment mistakes.
Five Quotes From Bill Keen in This Episode
- Human emotions make it difficult for investors to overcome normal market volatility. Small company stocks have performed well over a long period of time but that growth was accompanied by significant fluctuations along the way. If you were Rip Van Winkle and didn’t look at your small company stocks for 40 years, you might be pretty happy at what you saw when you woke up. The problem is we’re not Rip Van Winkle. We have to go through the emotion of seeing what these investments are doing every day. As a result, diversifying your investments across a variety of asset classes may help smooth out the returns so we don’t get scared out of our investments at exactly the wrong time.
- When markets are down, that may be a good time to “rebalance” your portfolio. During a bout of market volatility last fall, I was contacted by US News and World Report to offer my comments on the market. I gave a quote and wasn’t sure if it would be published because when I speak to the media, I don’t participate in the sensationalism. I simply said these types of volatile situations can create opportunities to rebalance portfolios for long-term investors. By trimming back holdings that may have appreciated in value and buying more of holdings that may have fallen in value, you can bring your portfolio back to your long-term target allocation. It also helps you to “sell high and buy low.”
- There is a difference between risk and volatility. Risk, in my mind, is the possibility of permanent loss. Volatility is the fluctuation an investment experiences over time. If you don’t act on that volatility by selling something after it’s down, then it’s just fluctuations. It turns into risk when you let emotions get in the way and you act on that volatility and turn a fluctuation into a loss by getting out at an inopportune time.
- One reason why we invest is to help us stay ahead of inflation. When I talk about inflation, I like to ask people to think back to how much they paid for their first car or their fist house. Chances are they paid substantially less than that car or house would cost today. This helps people realize that they may need some of their assets to be in asset classes that may provide a portion of their account with some nice growth even though it may be volatile. By investing, we may be able to generate a return on our money that is higher than inflation so we don’t fall behind and have a falling standard of living.
- The time frame for how long you need to invest may be much different than you think. One mistake I see people make is they think that if they are retiring in two years, their investment time horizon is just two years. The reality is for some of their money, yes, they will need it back beginning in two years to live on when they retire. But they certainly won’t need all of their money back at that point. Retirees may need some of their money to last 20 or 30 years in retirement so we have to be sensitive to that and match the time frame with an appropriate investment.
Bill Keen on investing…
Another mistake investors make is they look at their account statement and start chasing what just did best in the prior period and think it will continue to do well going forward. It doesn’t always work that conveniently.
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