Below are three truths every investor should know.
1. The Stock Market Doesn't Always Go Up
The following chart shows the S&P 500 (using a log scale) dating back to 1900. As you can see, there are several long periods during which the stock market went sideways, some lasting more than 20 years. Start on the wrong side of the market trend and a significant part of an investor's accumulation years (i.e. when they're working and saving for retirement) might prove fruitless. Usually, these periods of stagnation are not observable without the passage of time. The most recent example is the highly volatile, but effectively sideways market after the collapse of the tech bubble in 2000.
This is not unique to the US stock market. The following chart shows the Japanese stock market dating back to 1950. From about 1989 to 2009 Japanese stocks experienced a long, painful decline.
2. The Drivers of American Growth Disappeared a Long Time Ago
Real GDP growth is derived from a combination of population growth (net births + immigration) and productivity growth (output per worker). Much of post-Industrial Revolution US history is supported by massive inflows of immigrants and huge transformative technological advances – the steam engine, electricity, combustion engine – that fueled real GDP growth for decades. This effectively created economic value and surpluses of wealth across the economy, forming the foundation of the middle class amd the 'just society'.
In contrast, while we continue to innovate, most developments over the past decade have been incremental in nature. Moreover, the inflow of immigrants has slowed significantly. Consequently, growth has stagnated compared to what people became accustomed to during most of the 20th century, in some ways reversing some of the gains made by the middle class.
In the future, however, I believe artificial intelligence, machine learning and automation are transformative technologies that might again multiply output-per-worker, and thus real growth. The question remains whether those gains will be distributed to labor or owners of capital.
3. The Average Investor – and Their Advisor – Dramatically Underperforms the Broad Market
Emotions rule investing. Investors tend to buy after the market has risen and sell after the market has fallen. Moreover, they tend to trade too frequently, exacerbating the losses from their inherent ‘buy-high, sell-low’ strategy. Between 1997 and 2016, the average investor underperformed a buy-and-hold index strategy by a gaping 5.4% per year. Over the long run, that’s a lot of forgone retirement money.
Research shows that this isn’t limited to individual investors trying to do it on their own. A recent paper published in 2017 titled ‘The Misguided Beliefs of Financial Advisors’ examined the personal accounts of Canadian financial advisors and found that they too were swayed by the same biases as individuals, underperforming the broad market by 3% annually.