If you’re wondering how you will provide for you and your family’s financial security in the future, you’ve probably considered saving money in your IRA or 401(k), and investing it in broad mutual funds tracking the US markets. Or you may have already done this.
If so, you’ve probably been lulled in by the personal finance industry’s PR that, “in the long run, the US stock market has gone up 7% per year annualized, after inflation.”
Sounds great, right? 7% per year is a doubling of your assets roughly every ten years. Just stick that money in there, don’t touch it again (“buy and hold,” or “passive investing”) and watch your wealth double every 10 years! (That’s a 12-fold increase over 40 years!)
The problem is, there’s a dirty secret to the investment business–one that the people selling you this BS advice don’t want you to know, because it would put them right out of business.
If you look at average investor returns over the long run—in other words, the actual returns of actual people who put actual money in the markets over those time periods–it turns out that they end up getting about 1% per year over inflation on average. (See this Forbes article, “Why the Average Investor’s Investment Return Is So Low,” or Google “average investor returns” for further corroboration.) That’s a doubling roughly every 72 years.
Given that, at very best, an adult has about 40 investing years before retirement age (ages 25-65), that means, if you get the average investor returns in markets, and wait around another 30 years after retirement age (until you’re 95), you might see one doubling in your lifetime. And that’s optimistic, as most of the money will have been invested later in your career, not earlier.
WTF?!
If the markets have gone up, on average, 7% per year above inflation, why has the average investor only gained around 1% per year?
The reason is, markets haven’t just gone up steadily 7% every year. They have gone up (and down) in wild swings. The S&P went up 19.42% in 2017 (yay!) But it went down 38.49% in 2008 (not so yay).
Zig, zag, zig, zag, up and down, up and down, ending up with a 7% return above inflation on average over many decades.
It’s almost impossible to resist selling when the market is in serious bear territory. Remember in 2000-2002, after the dot-com crash, when the market went down around 10%, 13%, and 23% respectively 3 years in a row–around 40% total?
In 2002, when it was on its 3rd year of serious losses, how many people do you know who kept the faith, when everything was going FUBAR all around, and resisted selling during those years?
On the flip side, when markets are booming, people follow the momentum and buy more than they would otherwise, right at the peak.
“Buy high, sell low”–not exactly a formula for getting rich. But that’s what almost all investors in the markets do, and that’s why so few get any returns to speak of.
Meanwhile, what they do get is a bunch of ulcers watching all the manic-depressive ups and downs (and I should know, as I’m literally manic-depressive!! :-)~
The personal finance industry chalks this behavior up to a few strange, easily-fixable “biases” of human psychology, such as “overreacting”, “panic,” “greed,” or “over-relying on ‘gut feelings,'” As if these were just minor, strange quirks that can be remedied by reading one of their books.
But no, the average investor’s boom-and-bust, buy-high-sell-low psychology is not just some “quirk” that can be easily remedied with a book, or with a stern lecture from your financial planner.
Think of it like this:
Why Investing in the Markets is Like Walking Around With Mustard on Your Face
When a market is busting, everyone around you is selling, while you’re watching your portfolio go down and down, each day–if you haven’t sold already too.
You’re watching your kids’ college fund (or whatever) evaporate.
How many days can you watch you and your family’s financial future disappear, while your friends, your co-workers, and your partner’s sister’s cousin at the dinner party telling you they’ve all just gotten out and are now safe in the life-raft of cash, avoiding all the scary waves of these crazy losses?
Are you really going to keep having the faith in what that investment advisor or personal finance book told you then–about how markets always go up in the long-run? “Maybe they were wrong. Maybe things are different this time,” you think. Sound familiar?
In such a case, staying in is like walking around with mustard on your face. In fact, its worse that that. It’s like walking around with mustard on your face, while everyone else is telling you that you have mustard on your face, and that you should wipe it off!
The only way to stay in the market (which is the only way to make money if the market does end up going up in the long run) is to say, basically:
“I know I have mustard on my face, but I don’t care. I’m going to walk around with this mustard, for years, and in years, I’ll be able to wipe it off, and then I’ll be rich!”
How many humans do you know who can do that?
Inversely, when a market is booming, you’re watching everyone around you making crazy money. You just watched your neighbor roll that new Lexus into their driveway, and now they’re remodeling their kitchen.
And they’re asking you why you’re not getting in and getting rich on this “once-in-a-lifetime,” “historic” bull run! And they’re telling you you’re crazy not to.
Again, resisting the temptation to invest disproportionately when market hype-cycles are peaking, is like walking around with mustard on your face. Everyone else is wiping their own off. Everyone else is saying, “You’re a fool if you don’t get out of whatever cash and bonds you have, buy on margin, and get in on this historic bull market ASAP while you still can!”
So, you give in, wipe the foolish mustard off to fit in with the crowd, buy into the upward boom. And then you find out you’ve just over-invested at the peak, and you watch all the stock you just bought crash in the next bust.
And the cycle continues.
Up and down, up and down. Buy high, sell low. Buy high, sell low.
The Only Way to Make Outsize Profits…
The only way you can make out-size profits in anything is if you:
(1) go against the grain on some bet–the contrarian side no one’s on, and
(2) stick to your guns over time (i.e, walk around with mustard on your face, enduring ridicule, FOMO, criticism, people telling you you’re crazy, etc. as the bet looks like its losing), and
(3), do #1 and #2 on a bet that turns out to be right.
That’s it.
Everyone else loses money.
To do #1 and #2, you have to believe in what you’re doing.
To the core.
Enough to stick to your guns when every piece of evidence is telling you otherwise. When you’re almost ready to give up hope. You’ve got to stick with the faith.
And then (#3) you have to have chosen the right thing to have faith in.
It turns out, these 3 things are really really hard.
They take massive willpower. And a massive ability to resist temptation. And knowing something about the future (betting right) that know one else knows. (Because if they already know, they’ve already bid the price up.)
Do you really, really believe the US markets and economy will double, and then double again, and then double again, and again, in your lifetime, as they have in the past?
Do you believe in the continuation of this world-historical, highly anomolous rise, enough to stick to your bets for your whole lifetime, even when the inevitable crashes comes in the process?
I’m not saying the US markets and economy won’t do great in the long run.
I have no f$%ing idea what the markets will do in the next 10-40 years.
(As I said in my previous letters, I follow the wise man Socrates on these matters: I know that I know not. I also know that most other people know not.)
My point is, if the US markets do end up continuing their world-historical rise for another lifetime, the only way anyone will profit from it is to keep believing. And believing. And believing. Even through all the crazy busts and crashes that occur in any market over an average lifetime.
Believing in something, against the grain, is really hard. Investment advisors who say that avoiding wiping the mustard off your face when everyone is telling you to do it, is just some “quirk” of human psychology, easily-remedied if you follow the scientific advice in their book, are lying to you.
If you’re going to believe in something for your whole lifetime, against the grain, there’s another asset, another investment, another source of earning power, I think you should have faith in, and invest in.
It’s not anything that can be bought on a marketplace.
If you want to keep learning what a real investment is–an investment that’s actually worth believing in over the long haul, then stay tuned to this investment series I’m writing. Next update coming soon.
–Michael
PS My co-author Bryan Franklin and I give you a pretty strong clue–in fact, more than a strong clue, an entire life-plan for real investing, in our book “The Last Safe Investment: Spending Now to Increase Your True Wealth Forever.”
