This week I will summarize the second three of the six articles I cut out of the March 6, 2013 edition of The Wall Street Journal. I hope this will put some perspective on the market and the crazy media coverage generated:
“On Wall Street, Investors Plot Next Move” This article is very interesting in that it looks at the so-called record high in the perspective of taking out inflation from the results. Once you take out inflation, then the Dow hasn’t been in real record territory in more than 13 years. “The last nominal Dow record, in October 2007, wasn’t a record at all once inflation is removed. The last real, or inflation-adjusted, record was on January 14, 2000.”
Economists and some analysts state that investors should take inflation more seriously, according to Richard Sylla, a professor at NYU, “people could be fooled if they don’t pay attention to inflation.” While inflation’s effects are small over the short-term, they can have a significant effect over the long-term. Professor Sylla stated, “the Dow appears to be roughly 140 times its level of 100 years ago, an enormous gain. But removing price increases and counting only real gains, the Dow is roughly seven times its level of 100 years ago, a good gain but far from what it appears.”
Even over the past 13 years, the story is very different once inflation is taken out. “In nominal terms, the Dow today appears to have risen 22% from the record it hit in January 2000. But taking inflation into account, it still is more than 10% below that record.” In fact, if you wanted to match the inflation adjusted “record high” the Dow would need to hit 16,052.22 in today’s nominal terms.
“Keeping Up With the Dow Joneses” This article is more for geeks than regular investors in that it discusses the difference between price based indexes like the Dow vs. market capitalization of a broader index like the S&P 500. The bottom line is that a single index does not make a diversified portfolio.
“Latest Bull Run Is More Of A Jog” Because the effects of inflation, this rise in the Dow is not that significant due to the time it has taken to rise. The average bull market gained 102.85% over 887 calendar days, or about 2 ½ years. This bull run gained 117.7% over 1,457 calendar days. This means that this was a slow rise, not a robust move.
Emotions of Investing and the Articles Discussed Above:
While the past few weeks saw record highs for the Dow and S&P, it was also a record for me in the record number of clients calling and emailing me about how this record high was effecting their investments.
There is a very interesting area of study in Finance called Behavioral Finance. It is the convergence of both psychology and finance. Meaning, it studies the impact of emotions on the so-called rational behavior of investors. One of the most important roles you have hired me to assist with is to remove the emotion from your investing decisions. It is therefore my job to turn down the volume of the media hype surrounding any news in the market including the so-called record highs in market indexes.
So when I am asked the question, “how do the record highs affect my portfolio?” My initial blunt answer is that they don’t! Why don’t the stories about any single record high affect your portfolio? Simple, first is that you can’t fully invest in any single index. Every index fund tries to get close to matching an index, but it can never match it 100% due to purchasing into the mix of companies in an index and the fees the index charges. Second, the real key question is why would you want to invest just in an index?
If you try to invest in a single index does it match your risk tolerances? Does it fully diversify your assets? But most importantly, how does a single index help you achieve any life goal you desire to achieve?
The most important long-term annual study on the behavior of average investors vs. institutional investors is the Dalbar Study. This annual study looks at the returns of average investors. As the below chart shows, the “average investor” does very poorly when compared to a static index. Over the past 20 years the average investor earned only 3.49% return while the S&P 500 Index earned 7.81%. Why is this? Simply put, the average investor is subject to media hype and the roller coaster impact of short-term news and ups and downs in the market. An institution has a very long-term focus, but an average investor is concerned with a much shorter time horizon.
Here are the results of the 2012 Dalbar Study:
I hope this weeks article as well as last weeks have helped you put into perspective the media hype surrounding the so-called record highs in the market
To Your Successful Retirement!
Michael Ginsberg, JD, CFP®