Avoid making short-term decisions with long-term investments
April 3, 2014
The measurement of investments is often a bit of a moving target. One of the more difficult aspects of investing is measuring your success.
Many people find investing confusing. For example, combine the challenge of measurement with the fundamental characteristics of rising and falling stock market values. This difficulty is magnified by the importance investing has on people’s lives.
Your reasons for investing are to achieve the goals that are most important to you. Matters such as saving and investing to buy a house, educating your children and retiring in comfort are the foundation of people’s lives. The culprit is not the arithmetic of calculating investment returns. That is fairly basic and arithmetic is an exact science.
The issue is investing itself, due to the magnitude of normal stock market volatility. Depending on the period being measured the investment results can vary significantly by just slightly changing the time period being measured.
Investment decisions are often based on performance results and the absence of sound reliable data makes it hard for investors to use the data correctly.
As an example, we will consider the investment results over a five-year period using the Standard & Poor 500 stock index in the United States. Consider the 500 stocks included in that index as a proxy to gauge your own success if you had invested in the U.S.
At the end of 2012 your annualized five-year return was 1.7 percent. Using that information you might finally decide that investing in stocks was a waste of time and money. Instead, you move your money into interest-paying investments that pay a two or three percent return but without the risk of stocks.
Then just one year later these same five-year numbers tell a completely different story. Suddenly the stock market has become profitable and it is where you should be investing. For the five years ending in 2013 the annualized S & P 500 index produced an annualized return of 17.9 percent. Almost the same period but remarkably different results.
The reason for the significant change in performance is simple. The year 2008 which was horrible was replaced with the year 2013 which was very strong. In 2008 the S & P 500 index lost approximately 35 percent. In 2013 it gained about 32 percent. Two lessons can be learned about how the stock market works.
First, market gains and losses tend to be concentrated. If you are in or out of the stock market for short periods then your returns over time can be significantly different from the returns of the market in which you invest.
If you make the decision to invest a certain amount of your money in stocks then have the discipline to resist the temptation to manage your long-term investments with short-term decisions.
The second lesson is to look for longer time periods upon which to base your investment decisions. Five years might seem like a long period but when it comes to investing, it is not.
Begin by determining your time frame and when you have a long investment time horizon, then stocks should be considered for some of your portfolio.
Try to resist the temptation of basing your long-term investment decisions on short-term performance results.