There was no shortage of notable events during 2020. The first global pandemic in over one hundred years overwhelmed healthcare systems around the world and took a tremendous toll on human life, mental health, and the global economy. Civil rights marches occurred in many of our urban centers. The deeply divided political environment in the U.S. led to a fiercely contested presidential election, and the subsequent assault on the U.S. Capitol Building.
Of all of the events of 2020, the global pandemic caused the most disruption to the capital markets. By March of last year, much of the U.S. was under strict orders to shelter in place, and economies around the world grinded to a halt. The global capital markets followed suit with steep declines. From its high in the middle of February to its low in March, the S&P 500 dropped 34%, a historic decline into bear-market territory.
Just as quickly as they fell, the U.S. capital markets staged a remarkable comeback over the following nine months. Investors that had pivoted to cash or other safe-haven assets during the initial tumult, essentially locked in their losses. Those investors that stayed true to their long-term goals and asset allocations without allowing the vagaries of the market to influence their investment decisions, were handsomely rewarded. The S&P 500 finished the year up approximately 16%, an extraordinary turnaround considering its first quarter declines.
Winston Churchill once said, “Never let a good crisis go to waste.” 2020 provided no shortage of crises, and also served as a reminder of three investment principles that have withstood the test of time:
1. Diversification Takes the Emotion Out of InvestingMarket volatility can wreak havoc on investors’ emotions. The euphoria of a market run-up can just as easily cloud an investor’s judgment in comparison to the despair that sets in during the observance of a market crash. Prudent investors recognize that one of the best ways to take emotion out of investing is through the implementation of a broadly diversified portfolio.
Figure 1: To illustrate both investor sentiment or emotion, and poor market timing, we provided the above example that shows the S&P 500 Index performance from December of 1997 through December of 2015, layered on top of equity cash flows as portrayed by net sales into retail equity mutual funds on an annual basis.
2. Avoid Market Timing and Predictions
Across each asset class in the chart below, the average investor underperformed the respective asset-class benchmark by an approximate average of two percentage points per year. While the chart does not detail the underlying causes of the average investor relative underperformance, one can surmise that investor emotions, and overzealous trading behavior in the attempt to predict and time market movements, erode the average investor’s returns relative to the benchmark.
Figure 2: To illustrate average investor underperformance, we provide an example of three different asset classes: Large Cap Blend, Foreign Large Cap Blend, and
Intermediate-Term Bond, and their respective fifteen-year annualized total returns as of September 30, 2020.
To avoid the common pitfalls of market timing, investors should consider setting up a formal investment plan with a regular cadence of contributions. This concept is known in the investment world as dollar-cost averaging and can help reduce portfolio volatility risk as contributions are spread out over time instead of invested all at once.
Hiring an investment advisor is also a prudent choice, and can help insulate the average investor from poor investment decisions. Registered Investment Advisors (RIAs) are required to abide by the fiduciary standard, which compels them to act in the best interest of their clients. A savvy advisor should direct investors to use market peaks and troughs as rebalancing opportunities, which helps to maintain a disciplined, strategic asset allocation.It is important, however, to research advisor options, as excessive advisory fees may also erode your investment portfolio balance over time.
3. Patience is a virtue
The “Oracle of Omaha,” Warren Buffett is quoted as saying, “The stock market is a device to transfer money from the impatient to the patient.” The prior year was a blunt reminder of this principle.
The following charts demonstrate how patience has been proven beneficial, specifically as it relates to investing in the S&P 500. Between 1926 and 2020, the 1 year rolling total annual returns for the S&P 500 were positive 74% of the time. The same analysis applied to 15-year rolling annual returns shows positive returns 100% of the time.
Not every investor has time on their side, but for the long-term investor, these charts serve as a useful reminder that time will smooth out performance.