There is an increasing amount of commentary which suggests this time is different. Active management of portfolios is no longer needed, as Central Banks continue to be supportive of the markets, so join in on the “passive indexing” sweeping the country.
Of course, such commentary has always the case near the peak of a cyclical “bull market” as the psychological drive to “not miss out” erases the pain of the previous losses. This “exuberance” is what tends to lead individuals into making poor investment decisions as it relates to their long-term outcomes.
I was asked recently why an individual with 30-years to retirement should not just buy an index, invest money, and forget about it? With a 30-year horizon, they surely don’t need to worry about market volatility right?
Let me use the example for a previous study on the impacts of valuations and long-term outcomes. (See the full analysis here.)
“So, with this understanding let me return once again to the young, Millennial saver, who is going to endeavor at saving their annual tax refund of $3000. The chart below shows $3000 invested annually into the S&P 500 inflation-adjusted, total return index at 10% compounded annually and both 10x and 20x valuation starting levels. I have also shown $3000 saved annually in a mattress.”
“I want you to take note of the point made that when investing your money when markets are above 20x earnings, it was 22-years before it grew more than money stuffed in a mattress.”
The mathematical analysis suggests, at current valuation levels, individuals may be just as well off storing money in cash rather than investing in the markets. That is just the math.
The financial markets will do one of two things to your future financial security:
- If you treat the financial markets as a tool to adjust your current savings for inflation over time, the markets will KEEP you wealthy.
- However, if you try and use the markets to MAKE you wealthy, your capital will be shifted to those in the first category.
Let’s focus on the first one.