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by Michael Rogan
Special to Tropical Breeze
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Michael Rogan
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In a previous column, I attempted to
refute some common misconceptions regarding investing in stocks.
Such as, investing in the stock market is like gambling. Rather
than just argue the point, I attempted to help you understand how,
as a society, we came to believe that, and why that belief is
simply not supported by the facts. This time, I will both add to
the historical information that disproves the stock market's risk,
as well as put into perspective why this is so important that I
bring it up time and again in this column.
Around the day I was born, more than 44
years ago, the Dow Jones Industrial Average stood at about 720. As
I write this, it stands today near 14,000. And it is not a minor
point that the Dow (like most indices) doesn't count dividends. If
dividends were counted and assumed to have been reinvested, the
index would be over 50,000. Now, this does assume you either had a
tax deferred investment or paid the taxes on the dividends from
some other source, but if the market could go from 720 to 50,000 in
just my lifetime, how did we ever come to think of it as risky?
The answer lies in how we define risk. In
the investment profession, when we speak of risk, we are talking
about a statistical measure of an investment's volatility. When
most of you speak of risk, you are describing the permanent loss of
your money. This difference, I believe, can explain a major
disconnect between the suppliers of investment advice, and the
consumers of the advice. It is why virtually everyone fails to
build wealth through their investments.
On average, the stock market advances four
out of every five years. On average, in that fifth year, it
declines 30%. From the above discussion we must conclude that all
advances are permanent, and all declines are temporary. So, how
could an "investment" that appreciated from 720 to over 50,000 come
to be considered risky? Clearly, the answer lies in what we do
during that fifth year, 30% decline.
The study of behavioral finance tells us
(perhaps what we already knew) that we feel much more pain from
losing money than the pleasure we get from making money. This is
understandable. We are all emotional creatures. Consequently, we
are all more likely to be quick to take a profit (as it's always
enjoyable to realize a profit) and slow to take a loss (because
after all, the investment could recover, and we all would rather
postpone the painful realization of a loss). Unfortunately, as a
trading strategy, this is backwards. I don't advocate trading
anyway, but if you insist, you should really sell your losers
quickly and let your winners run.
It's exactly this behavioral fact that
explains why index fund investing, while arguably logical in
theory, is nearly always unsuccessful in practice. (And that is
why, incidentally, Exchange Traded Funds — ETFs — that
allow you to trade index funds more quickly, are even more of a bad
idea). We have already established that successful long term
investing primarily requires you to just leave your investments
alone, but no one can do it. Index funds, which drop exactly as
much as the market in that fifth year downturn, offer no downside
protection. Consequently, nearly everyone jumps out of them in a
downturn, and then waits for the market to recover before getting
back in.
Here's what you need to know. For most of
us, a diversified portfolio invested primarily in the stock market
is the only mathematical option that will allow a retirement where
we don't deplete our principal and risk running out of money.
That's simply a math comment, not a recommendation. The stock
market is going to get more expensive throughout your lifetime.
It's an immutable fact. Everything you need to buy also gets more
expensive each year, whether you like it or not. If you are not
invested sufficiently today with a nest egg that could provide you
rising income in retirement so you won't run out of money, you're
not all in yet. Everyday that the financially illiterate talking
heads in the media describe a day where the stock market rose
significantly as a "good day on Wall Street," you need to ask, for
whom? Certainly not for you, because you're not all in yet.
Accordingly, you really should cheer each day the market declines
as a new opportunity for you to add to your holdings before they
get more expensive. (I don't think you will, but you should.)
And every time the media screams that the
stock market has hit yet another "all time high," you should say,
"So what else is new?" In my career, the Dow Jones Industrial
Average has broken through, for the first time ever, each
millennial milestone from 2,000 through 14,000. It's always
hitting a new all time high. It's just the times it pauses (those
fifth years) that make us forget.
Michael Rogan is president of Rogan &
Associates Financial Planners, a locally-owned financial planning
brokerage firm based in Safety Harbor. He brings nearly two decades
of financial expertise to the local airwaves on the radio show,
Financial Planning for Life, heard at 11 a.m. weekdays on AM 1250
WHNZ. For more information, call 727-712-3400 or visit
www.RoganFinancial.com.
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