We are closing in on a decade since the 2007-2009 stock market “meltdown.” Rarely a week goes by that someone I encounter doesn’t refer back to 2007-2009 as a period where they “lost 50%” on their investments. Indeed, the S&P 500 Index declined by 57% from the peak in October 2007 to the bottom in March 2009. What is missing in this discussion, however, is that investing is not for a year or two but for a lifetime. If you focused too much on the 17 month long period above, you likely missed out on the subsequent 7 year long bull market which has seen the S&P triple in value from the 2009 bottom.
This dilemma is perhaps the most important (and most vexing) financial planning question that you face as an investor. The ultimate reason for investing ties back to the need to offset inflation over time. Using market history as a guide, it is difficult to see how you can outpace inflation unless you have permanent exposure to stocks.
Consider the 30-year timeframe from 1986-2015. The simple chart below details why investing in stocks is generally a more reliable path for accomplishing financial planning goals. The real risk, therefore, is staying out of the market.
From these observed historic returns, you see that before taxes, One Month Treasury Bills exceeded inflation by 0.8% per year. Once taxes are considered, these returns are likely near zero or perhaps even negative if you are in the upper income tax brackets. On the other hand, the 60% stocks/40% bonds Global Balanced Strategy exceeded inflation by 6.9% per year before taxes.
Perhaps the most important financial planning decision confronting you is how much certainty, (as in Treasury Bills), do you need? How much certainty can you afford? As the chart shows, certainty and returns are inversely correlated. The key to being able to stay with a well conceived financial plan comes down to your ability to tolerate lack of certainty.
Don’t the innate risks of investing pale in comparison to the very real risks of not achieving your particular financial planning goals? Shortfall risk may well be the largest risk of all. How are you handling this risk? Ready for a real conversation?