Why the Best Investors are Like Rip Van Winkle
Stocks are going to crash. I don’t know when. But they will. US stock market CAPE ratios (a measure of expensiveness) are near an all-time high, and we haven’t had a double-digit calendar year decline for twelve years. In fact, over the past dozen years, we only had one calendar year drop: US stocks fell about 4.5 percent in 2018.
A $10,000 investment in Vanguard’s S&P 500 index on January 1, 2009, would have grown to $63,268 by August 23, 2021. That’s more than six times its original value over just 12 years.
Growth of $10,000 invested in S&P 500
January 1, 2009-August 23, 2021
|Year End Value|
*To August 22, 2021
Sources: portfoliovisualizer.com and Morningstar, using returns of Vanguard’s S&P 500 Index (VFINX)
As I write this, the CAPE ratio for US stocks is 38.91 times earnings. That’s far higher than it was in 1929, before the biggest crash in market history. It’s also getting close to the level we saw in 2000. That year marked the beginning of the lost decade for US stocks. If someone invested $10,000 in the S&P 500 on January 1, 2000, it would have been worth $9,451 on September 31, 2011. For almost eleven years, US stocks bounced up, down, up and down without making headway.
This is all true, and it might look useful. But this information is as healthy for your money as arsenic to your health. Instead of knowing any of this, in fact, investors would all be better off if they were like Washington Irving’s character, Rip Van Winkle. He drinks some strange liquor, falls asleep and wakes up a couple of decades later.
The less you follow the markets, the better you’ll perform. Fidelity’s best investors are reported to be those who forgot they had accounts with Fidelity…or they were dead. Unfortunately, most people don’t earn the long-term profits they deserve because they tinker with their money when they speculate. Sometimes, they act out of fear or greed. Other times, they’re urged by somebody’s supposed fortune-telling prowess on the radio or TV.
When US stocks crash (and they will), plenty of people will freak out. You’ll be bombarded by media sources profiling stone-faced “experts” who will dourly claim, “Our economic indicators suggest blah, blah, blah.”
The investment process is simple. If you’re working, add regular sums to a diversified portfolio of index funds. It’s even easier with an all in one fund. If you’re retired, withdraw an inflation adjusted 4 percent per year. Even if you retire on the eve of a market crash, you shouldn’t run out of money over a 30-year duration.
Notice what the process doesn’t include. It doesn’t suggest looking at the markets, following economic news, trying to time the markets, or listening to that blah, blah, blah on market-based TV. Stocks will crash from time to time, but nobody will know exactly when. That’s why it’s best not to worry about market crashes.
That’s easier said than done because humans think short-term. And that makes us bad investors. We worry about today’s returns, this week’s returns, this month’s returns or this year’s returns. Even a decade-long return is irrelevant. Consider that “lost decade” again from 2000 to late 2011 when US stocks didn’t earn a profit. Assume someone retired in January 2000 with $500,000 invested in a portfolio comprising 60 percent in a US stock index and 40 percent in a bond market index. They began their inflation-adjusted withdrawals at the start of the “lost decade.” After almost 22 years, they would have withdrawn $543,849.
That would have been a bad time to retire, and you might wonder if they had anything left today. The answer is, “yes.” After withdrawing $543,849 from their initial $500,000 portfolio, they would have had $570,495 remaining by July 31, 2021. That’s even more than they had before they started withdrawing money.
If their portfolio comprised 40 percent US stocks, 20 percent international stocks and 40 percent US bonds, they would have had about $538,203 remaining by July 31, 2020.
How many retirees do you think managed to pull that off? In most cases, I suspect it was just the investment equivalents of Rip Van Winkle: those who dispassionately withdrew an inflation-adjusted 4 percent per year and didn’t care (or even know) what was happening in the markets.
Following the economy and the markets is not just irrelevant to most people’s success— it’s actually detrimental. The markets, after all, are never an investor’s greatest risk. The greatest risk, instead, is the person we face in the mirror.
Whether you’re young and adding money or retired and withdrawing money, we should think of our investments based on 30-year durations. After all, stocks aren’t very risky when we think, long-term.
Retirees, I can hear what you might be saying: “I’m 80 years old. I don’t have 30 more years.” No, you might not. But if you live to 100, you’ll have 20 more years, and if you play with Vanguard’s Monte Carlo calculator, you’ll see that by withdrawing an inflation-adjusted 4 percent, the probability of a diversified portfolio of indexes lasting 20 years is higher than it would be over a 30-year duration. It goes without saying that the odds are even better over a 10-year duration. So, focusing on a 30-year period isn’t silly at all.
For younger investors, the longer the duration, the lower the risk. The worst 30-year period for US stocks was from 1929-1958. That period included The Great Depression. But despite the massive drop in 1929 and the early 1930s, according to the calculator at DQYDJ (Don’t Quit Your Day Job), US stocks averaged a compound annual return of 8.24 percent from 1929-1958.
Morningstar Direct releases annual returns for global stocks (a combination of US stocks, developed market stocks and emerging market stocks) from 1970. There were 22 rolling 30-year periods between 1970 and 2021. Along the way, they included some horrible years for stocks…even some horrible decades. But the worst 30-year period for global stocks (1990-2019) still recorded a respectable compound annual return of 7.62 percent.
If I had the power to ban market-based television, make it illegal for anyone to quote stock prices and make sure nobody could see their investment statement, investors as a whole would wind up richer. Or, it just might be easier to bottle Rip Van Winkle’s liquor.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas
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Please note the value of investments can go down as well as up, and you may not get back all the money that you invest. Past performance is no guarantee of future results.