Investors often go to great lengths to avoid uncertainty. This has particularly been apparent since the market pullback in 2008. Investment and insurance products promising stock market returns without market risk have sprung up like weeds in a garden. No one particularly likes uncertainty, but how far should you go to attempt to transform uncertainty into certainty?
Here’s the Price Tag
The actual price of pursuing a “risk minimizing, certainty maximizing” strategy is very likely financial failure. Yep, you will either flat run out of money or, just slightly more desirable, your lifestyle (adjusting for living cost increases) will trend lower year after year.
Despite these very grim outcomes, investors flock to products that promise to limit market fluctuation. With few exceptions, these products usually have an insurance component that is both complicated and expensive. These are attributes precisely the opposite of what goal-focused investors need. High annual expenses, sales charges, and surrender fees combine to equal a really bad deal for investors.
Fear of the Market
The innate proclivity to fear the stock market is magnified by the hour-to-hour focus of the financial media. The media portray the market as being directly tied to the short-term economy. Whatever may be happening today…tomorrow is likely going to be worse. The end is near.
To put the price of certainty in clear math terms, it is instructive to consider the return on U.S. Treasury Bills (1 month) as a proxy for “certainty” and the S&P 500 as a proxy for “uncertainty.” The current yield on the U.S. Treasury Bill is about 1.68%. That is about as certain as you can get. It also assures you of losing purchasing power to inflation, currently running at an annual rate of about 2.4%. Even worse, you have to pay income taxes on the income, which will push your actual after-inflation return further into the negative category.
Conversely, the annualized return for the S&P 500 since 1926 is 9.8%. This is almost 6 times the U.S. Treasury Bill return. This return may also be subject to taxes (capital gain and regular income). Of course, the range of returns in any given year can vary substantially. The best calendar year for this index was 54% (in 1933) and the worst calendar year -43% in 1931.
Neither of these extremes constitute a well-diversified portfolio, but they demonstrate polar opposites in terms of expected returns.
Evidence Contradicts Fear
As these returns indicate, the culture of market fear is entirely based on the short term, since all of the long-term evidence directly contradicts the fear. The product purveyors know very well that fear is an emotional response. They are quite willing to lead you far away from the proper path toward your financial goals.
We can’t totally undo our emotional wiring, but we can be aware of the potential negative impact on our financial life. Many young people refer to mundane grown-up things as “adulting” (a gerund- derived from a verb but functioning as a noun). Ultimately, we have to control emotions in order to achieve adult outcomes.
What price for certainty? Awfully high!! Bad advice can be very expensive. Ready for a real conversation?