Investing in the stock market can feel at times like the cruelest of games – one that only the most self-loathing, pain-seeking types of people would choose to put up with.
At the same time, it’s the only “wealth-building” solution that’s been offered to mainstream Americans – you know, average folks who work hard, save money and one day hope to retire.
To be fair to the establishment’s “buy-stocks-and-just-hold-them-forever” mantra, stocks have indeed been a powerful wealth-builder for more than a century.
Clearly, the U.S. equity market exhibits a bullish bias – namely because of earnings, inflation and, in more recent years, the simple fact that baby boomers have used it like a retirement piggy bank.
That’s why stocks have benefitted investors with average annual returns roughly between 6% and 8%. And that’s why proponents of buy-and-hold have a leg to stand on. It’s hard to argue with the stock market’s long-term track record.
That is… with one important caveat.
The buy-and-hold philosophy requires a commitment that the vast majority of the investors I’ve met simply aren’t able to make. That is, a commitment to be in stocks for the long haul.
How “long” is the “long haul,” exactly?
I’d say a decade, at bare minimum. Two to three decades is even better.
But it really doesn’t matter.
People will tell you that if you’re, say, 30 years away from retirement, then you can invest full-bore in stocks because stocks have always gone higher over a 30-year period.
It sounds good in theory. But as the late, great Yogi Berra said: “In theory there is no difference between theory and practice. In practice there is.”
In 2008, I was working as a financial advisor. And so I personally experienced the level of commitment that average investors have to stocks, in practice, when times get tough.
You see, in theory, any investor who was about 50-years-old or younger should have simply held their portfolio of stocks through the Great Financial Crisis of 2008. “Invest for the long-haul,” right!? That’s what buy-and-hold requires – your dutiful long-term commitment.
But in practice, that’s not what happened.
Long-term buy-and-hold investors always have good intentions when they’re new to saving and investing. And of course also during bull markets.
But when a bear market strikes, let alone a full-blown global financial crisis, most investors panic. And they do it only once that crisis has already been confirmed. By then, it’s too late.
That’s the really painful part of this story: most investors don’t abandon a bull market when it’s down 10%. Most investors don’t sell stocks when they’re down 20%.
Cruelly, most investors sell stocks at precisely the worst time – when they’re down 35%… or 45%… or 55%… or worse.
Simply put: investors are their own worst enemies.
I’ve witnessed this first-hand continually throughout my career. But you don’t have to take my word for it. There’s a study I like to quote, done by Dalbar, which shows the average annual return of a variety of assets, including stocks.
Between 1992 and 2011, the S&P 500 gained 7.8% per year.
But the average investor earned just 2.1% over the same time frame.
This seems illogical – since a majority of investors invest in stocks, shouldn’t they earn closer to 7.8%?
Well, the answer is yes… they should have, if they were truly loyal to their commitment to long-term buy-and-hold.
And there in lies the problem.
For psychological reasons that are just now being researched, the vast majority of Main Street American investors simply can’t keep their paws off the panic button when stock-market calamity strikes.
We buy… we hold… and then we jump ship at the worst time possible – only after our max-pain thresholds are far exceeded and our accounts are down 50% or more.
Like I said… it’s cruel! But it’s the truth.
The good news is that there’s a very simple solution to this dilemma.
It’s a solution that allows long-term investors to fully participate in the long-term returns that stocks have produced for decades. But it also protects you from the brunt of bear markets and financial crises.
This strategy is all about capital preservation. And I’ll show you next week how you can use it to reduce the risk in your stock portfolio by more than 50%.
Chief Investment Strategist, Dent Research