Suppose I offered you a choice of two investments:
Over a five-year period the first investment lost an average of 0.6% per year.
The second investment had a 5 year average annual return of 17.7%.
So which would you choose. Seems like a no brainer. Of course, anyone would choose the 2nd investment.
Now what if I were to tell you that they are the same investment? How can that be??
A matter of timing
Actually both of those investments are the S&P 500. The difference is the first investment represents the 5 year average annual return from 2008 through 2012. The second investment is the S&P 500’s average annual return from 2009 to 2013.
In 2008 the S&P 500 lost a disastrous 36%, but in 2013 it posted an outstanding 26% gain. So the net effect of dropping a 36% loss on one end and adding a 26% gain on the other side is what accounts for the 18.3 % change in the 5 year average annual return.
Clearly, over a 5 year period results can be skewed, but what if we looked at a 10 year period instead?
From 2003 to 2012 the S&P 500 had an average gain of 7.0%. Move that forward one year and from 2004 to 2013 the 10 year average annual return was 7.3%.
Quite a difference from the volatility we saw with 5 years.
Lesson #1: Avoid advisers who cherry pick
So what can we learn from this? There’s an old joke that says there are lies, #$@#($ lies and then there are statistics.
The first lesson is be very careful when someone tries to sell you an investment with a short track record of success. Advisers who cherry pick among statistics to make their recommendation look good are dishonest sales people at best, and crooks at worst. If you have an adviser who uses these tactics, it’s probably time to find a new adviser.
Lesson #2: Look for long track records
The second lesson is when you are looking at investments you should always look for investments that have a long track record. 10 years is a minimum. I prefer investing in funds that have been around for 20 or 30 years or more. Funds with long track records show that they are capable of sustaining a good return through good times and bad.
Lesson #3: Short-term results can be skewed
Be aware if you are looking at investments that the 5 year results probably changed radically on Jan. 1, 2013. On that day a very bad year dropped off and was replaced by a very good year. If you review your investments and are looking at 5 year results, you probably are seeing a very different picture today than you saw a few months ago. Bottom line is you should be making your decisions based on longer periods.
Lesson #4: 2008 was not the end of the world
Many people were scared out of the market by the rough ride that was 2008. But as you can see from that 17.7% average gain, the last 5 years have been very good. But those who decided the market was just t0o scary and cashed out in 2008, have missed all those gains.
Lesson #5: Investing for the long-term
Lastly, investing is always about the long-term. If you are going to need the money in a few months, you should not be investing it in the stock market. The short-term risk is way too high. No one knows what the market will do in the next few months, or any short period of time.
What history has shown us though is that as you take longer periods of time, investing in the stock market is one of the best ways to make money, but only if you plan to put it there and leave it there. Investing is a little bit like a roller coaster. There are ups and downs and crazy stomach wrenching turns. But remember the only people who get hurt on a roller coaster are those that jump off.