The new year had barely begun when Carl called to sit down with me and Warren to discuss his financial goals for 2014.
I have always admired Carl’s work ethic and discipline to save for a rainy day. Furthermore, he recognized that although the oil field had treated him and his family quite well he knew how cyclical it can be.
Recognizing this, Carl had saved a bit of money and was looking for direction on how to invest it.
The first words out of his mouth were “I want something safe—like bonds.”
Whether the fixed income markets are considered safe or not—they are financial assets which are volatile in nature. As we explained this to Carl, we added that if he had invested in the broad fixed income market last year he would have lost 2.2% on his money.
That was not what Carl anticipated. However, it offered a good opportunity to remind him that when interest rates rise, the value of existing fixed income assets drop in price. That is exactly what happened in 2013.
Carl leaned back in his chair and thought for a minute. Then he said what was really on his mind: “The stock market scares me—it has gone straight up since 2009. I’ll just wait for the market to drop and then I’ll get in. I don’t want to jump in like I did in 2007 only to watch my funds drop like a rock.”
The drop in 2008 and 2009 was not fun—but it was not that unusual. We tell our clients that invest in the stock market to expect a 40% drop in any one year and up to a 60% drop over any two year period. For this reason, we always want our clients to have at least a ten year time frame when investing in stocks. Having a longer time frame allows the patient investor to ride out the markets irrational and volatile periods.
As I reminded Carl of this conversation he said, “I just don’t want to invest at the peak of the market again.”
Warren had been quietly listening to the conversation. He then asked Carl what he thought the annual returns of the stock market would have been if he had invested at the peak of the market. Carl thought a bit and guessed that he’d be about breakeven—but only after more than six years later.
Warren immediately started tapping the keys on his financial calculator. A minute went by and then he started to smile. From October 11, 2007 through January 9, 2014 the annualized return of the stock market was 6.17% with dividends reinvested. Carl was surprised. He did not realize he had made that much.
Warren then made an even more impressive point. He asked Carl what he thought the returns were had he started investing $100 a month at the peak of the market and then continued to add to his portfolio each and every month through January 9th.
Carl thought for a minute knowing it should be greater than 6.17%. Warren had an even bigger grin on his face this time. After he finished running the calculations he revealed that a disciplined investor who started at the peak, but continued to invest each month produced an 11.41% annualized return with dividends reinvested. Carl was amazed.
As we continued the conversation we discussed the fact that we have no idea what the stock market will do tomorrow or over any short period of time. So quit trying to time the market. We also recognized that although the stock market has averaged about 10% per year over very long periods of time—it is a very bumpy ride.
Knowing this, Carl recognized that “time in the market” was far more important than trying to “time the market.” He also left with a better understanding that disciplined investors who consistently invest in good and bad markets generally achieve the best long term results. They also sleep better at night knowing they have a logical long term plan.