The Vanguard ‘spectrum’ graph below reminded us of the song: “Red and yellow and pink and green, orange and purple and blue. I can sing a rainbow, sing a rainbow, sing a rainbow too.”*
When you stop singing and have a proper look, you’ll see that the x-axis shows how the different mixtures of equities and bonds have performed from 1900 to 2018. There are lots of lessons you can learn from this.
As you can see, there are some really good gains over this long period.
That means you shouldn’t be tempted by quick wins (or scared by short-term losses). Stick with it, and you’ll benefit even more.
Now look at the red bar at the edge of the graph.
Left to your own devices, you might say “I want 100% equities so that I get the best rate of 150.74% return! I’d even be happy with the top average of 9% per annum!”
Yes, the rewards are potentially higher, but so is the volatility.
In the 1970s, the market fell by half. If that happens again, would you want to sit on it? Or would you panic? If you sell, you would crystallise that loss. So stick with it! Because even when the market plummets, it picks itself up again in due course, and ends up even better than before.
Volatility is our friend! It’s essential to a successful investment experience. Volatility is often described as ‘risk’, but over time the risk of any capital loss diminishes. You have to accept volatility to harvest the returns offered by the stock markets. If you can’t accept volatility, you shouldn’t play the game!
These quotes explain more:
“Fear is the most critical, functional cog in the investing machine. It’s got to remain present and front-of-mind in order for there to be any future upside for investors to capture. Stock investors get paid for facing these fears because so many others will not face them. When the possibility of loss goes away, so does the probability of gain.”
Joshua M Brown, Why the stock market must go down
“Markets won’t give you a ride without some bumps along the way. You have to experience some downside to earn your upside.”
So what portfolio should you be in?
The above shows you the ‘science’ but choosing the right portfolio is the ‘art’ of a good financial planner. Looking back at the graph, we might recommend your portfolio is more like 50:50 equities and bonds. There is less upside, but there’s less downside too, so that’s not a bad thing.
Things to remember
We’ve often said that behaviour is key in investing. And that’s why we base our advice on science, not on emotion. With that in mind, you might like to read (or re-read) our other articles:
We’ve also often talked about the illusion of skill, which is deeply engrained in the industry. Active fund managers may fondly imagine they can outperform the markets with their guesses, but the evidence just doesn’t stack up, as we explained a while ago:
The best way to win investment gains is to make a plan that includes low-cost funds and is diversified… and then ignore the media hype and stick with it! We reinforced that message here:
How we help
As financial planners, we take the emotion out of investing. We‘ll help choose your portfolio and will always advise you NOT to bail out if / when the markets fall. We will advise you to stick with it because markets always rise over the long term.
As evidence that we really do make a difference, studies show we can grow the average portfolio by 3% more than clients would manage without us (evidenced by The Dalbar Study). This is called ‘Adviser alpha’. For more on this, please see our article 2+2=4
If you have any questions, please give us a call. We’ll be happy to explain more.
*Do you remember that song from your childhood? If not, here it is on BBC school radio.