How I fell out of love with the stock market
For a whole variety of reasons, all of them bad, I didnâ€™t put so much as a dollar into a retirement account until I was 36 years old.
When I did start saving, I followed these four standard pieces of personal finance advice:
- For long-term growth, put most of your money into stocks, balanced by a small percentage of bonds
- Keep costs down with ETFs when available, and the lowest-cost mutual funds when ETFs are not an option
- Diversify by owning broad swaths of the stock market, such as a total stock market fund or a S&P 500 index fund
- Buy and hold rather than trying to time the market; rebalance to percentage allocations
Now, in the aftermath of the second-worst stock market crash in American history, I still subscribe to the last three principles. However, Iâ€™ve completely rejected the first one. I no longer keep a majority of my investments in the stock market.
In fact, I no longer keep even half of our joint retirement savings in stocks.
Almost everyone loves stocks for long-term investing. Robert Brokamp, writer at the Motley Fool and Get Rich Slowly, goes so far as to say, â€œThereâ€™s really only one place your retirement savings should goâ€:
The inexorable pressure on the stock market is upward. The biggest bang for our buck will be found in stocks. … Stocks beat bonds for 90% of the rolling 10-year periods, and essentially 100% of the rolling 30-year periods.
He admits, but downplays, the fact that â€œfrom 2000 to 2002 many people lost more than half their life savings in the marketâ€.
Well, in 2000 times were tough all right, but I didnâ€™t have any investments. I had credit card debt instead. So 2008 was really the point at which I discovered that I was not okay with losing half — or even a third or a fifth — of my hard-won savings.
The truly difficult part, however, was finding an alternative. Bonds, as pretty much everyone points out, do worse on average than stocks. Cash is a losing proposition at this point, as even top-rate 5-year CDs canâ€™t keep up with inflation.
Whatâ€™s a risk-averse girl to do?
Eventually, I ran across an option that made sense to me. Itâ€™s called the â€˜Permanent Portfolioâ€™ and mercifully, it also happens to be simple.
Take one-fourth of your savings and put it into each of the following:
- total stock market
- long-term Treasury bonds
- gold bullion
The basic idea is that no matter whatâ€™s going on with the economy — prosperity, recession, inflation, deflation — some portion of your money is going to be doing well enough to offset the losses in the other part.
In fact, out of the last forty years, the PP has lost money only twice, with the largest loss being less than 4%. (The PP has only been a viable strategy since 1972, after the US went off the gold standard.) By contrast, the stock market has had ten out of forty losing years, including six years of losses in the double digits.
The compound annual growth rate of the PP hovers around 9.7% year-over-year. Thatâ€™s very close to the historical average return of the stock market. (For a detailed breakdown, see Craig Rowlandâ€™s post on the PPâ€™s historical returns.)
Iâ€™ll come back to the mechanics of the PP another time, but for now let me point you to JD Rothâ€™s excellent write-up from April of 2009. He liked the Permanent Portfolio for most of the same reasons I do.
Investopedia offers this on the subject:
â€œToday, many analysts agree that Browneâ€™s permanent portfolio relied too heavily on metals and T-bills and underestimated the growth potential of equities and bonds.â€
To which I say: if so, â€˜many analystsâ€™ are missing the point.
The point is not to outperform the stock market every year. In fact, if the stock market is doing spectacularly well, the PP is guaranteed to significantly underperform it.
But hereâ€™s the flip side: when the total stock market is doing spectacularly poorly, the PP will chug right along, hardly missing a beat. Next to the PP, any variation of the standard stock-bond dichotomy looks about as stable as a two-legged cow.
At the end of 2008, when our household suddenly lost 80% of our income, our already-insufficient pool of retirement savings was also hemorrhaging tens of thousands of dollars. If weâ€™d been allocated into the PP at that time, our retirement fund would have remained steady, even seen incremental growth of 1% or so.
That kind of stability and controlled growth is worth a lot to me. Itâ€™s worth missing a chunk of the upside of a bull market sprint.
Is it worth it to you? Letâ€™s find out.
You have $100,000 invested. Your gains for the year were modest $7,500. But everyone else you know is flying high with a 31% return. You thought you were being smart to play it safe, but now youâ€™re kicking yourself for having missed out on a $23,500 gain.
You have $100,000 invested — or you did, before the nosedive which cost you $36,700 in a single year. You have a lot of company, as almost everyone else suffered huge losses too. But not your best friend, whose portfolio had a tiny uptick of 1.9% for the same period. If youâ€™d only listened to him last year you wouldnâ€™t have lost a thing.
Which of those two situations is more stomach-clenching for you?
Scenario A is the downside to the Permanent Portfolio — thatâ€™s what actually happened to PP investors in 1997, as compared to the Total Stock Market.
For me personally, Scenario B is worse. Thatâ€™s what a Total Stock Market investor experienced in 2008.
If youâ€™d happily take A to avoid B, you should consider moving into the Permanent Portfolio.
My educated suspicion is that most people would choose A over B, because of the psychological phenomenon known to behavioral economists as loss aversion. In a nutshell, the prospect of losing something is much more painful than the prospect of failing to gain the exact same thing.
On the other hand, sticking with the PP means actively avoiding herd behavior, which is not an easy task for most humans. Weâ€™re wired to feel better when we do the same things other people are doing.
And most investors are not limiting their stock market exposure to 25%.
Hereâ€™s the other factor: I no longer believe in the inevitability of stock market growth, at least not over periods corresponding to a single human lifetime.
That oneâ€™s life savings should be invested primarily in stocks, with a small percentage of bonds for ballast, is one of those bits of common financial wisdom, like â€˜mortgage debt is good debtâ€™, which at first I just accepted as given.
Even in the midst of contradicting evidence, I didnâ€™t question the precept. Events like the crash of 2000-2002 were always characterized as minor speed bumps on the highway to certain riches.
But I now believe that the idea of the â€˜inexorable upward pressureâ€™ of the stock market will eventually be considered as naive and foolish as the idea that â€˜housing prices always riseâ€™.
The details are for another time, but over the last three years Iâ€™ve studied enough of both history and global economics to have concluded that the growth period in the United States from 1975 to 2000 was both artificial and unsustainable, and that even the larger run-up going back to the end of World War II was a generally unrepeatable one-time historical event. In the words of Yale economist Robert Shiller, â€œThis was the most economically successful century for the most economically successful nation of all time. It will not necessarily repeat itself.â€
Worse, I have become convinced that much of the value supposedly created in the last quarter of the twentieth century was actually borrowed from the future, and that what weâ€™ve seen over the last few years is, in a way, the very first of those debts coming due.
There will be more losses ahead. A lot more, probably spread out over decades.
Along the way, though, US stocks will still have some banner years. After a bumpy and ultimately lackadaisical 2011, the market has leapt out of the gate in early 2012. Itâ€™s entirely possible that this will be one of the years in which a simple total-market index fund leaves my portfolio in the dust.
Iâ€™m okay with that.
As PP enthusiast Craig Rowland has said, â€œEveryone thinks their horse is the one thatâ€™s going to win the race. I donâ€™t want to win the race. I just want to finish without having my horse break a leg and need to be put down for good.â€