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  • Short-term decisions can take a toll on long-term returns.
  • Most investors underperform the S&P 500 index.
  • The odds of positive returns increase alongside your time horizon.

If you’re a long-term investor, it’s important to remember that changes to your portfolio because of short-term media headlines or investor commentary can reduce your returns.

The biggest mistake long-term investors make is changing asset allocation at the worst time. Those eager to stop the pain of loss may sell their stocks when the newsflow is worst, and they struggle to buy back their original holdings when the market regains its footing.

Perhaps, this is why investors’ historical average annual returns significantly lag the returns for the S&P 500.

Most investors underperform

In the latest Guide To The Markets, J.P. Morgan Asset Management includes the following chart showing historical returns for various asset classes.

As you can see, the S&P 500’s 9.5% average annual return since 2002 is significantly higher than the 3.6% return of the average investor, based on aggregate mutual fund buying and selling as calculated by Dalbar.

CHART_Street-Smarts_2_080822

The average investor's return is also much lower than the 7.4% average annual return associated with a 60/40 portfolio, a common approach that involves investing 60% of assets in stocks, such as the S&P 500, and the remaining 40% in high-quality fixed income assets.

A steady hand can pay off

Although extrapolating market strength or weakness is tempting, stocks are a leading indicator. They move up in advance of the economy improving and sell off before it deteriorates. As a result, periods of poor performance can follow fantastic returns and vice versa, making it tough to handicap what happens in the short term.

Stocks' short-term ‘unpredictability’ is why Vanguard’s founder, Jack Bogle, favored a buy-and-hold approach to index funds. It’s also why Warren Buffett embraces a long rather than short time horizon, and why he wants 90% of his assets stashed in an S&P 500 mutual fund after his death, rather than trading in and out of individual stocks.

Historically, the likelihood of positive returns increases alongside an investor’s holding period. The following chart shows that the S&P 500's returns range between a 47% gain and a -39% loss over a one-year holding period since 1950. However, if you stretch the holding period to 10 years, the worst loss is -1%. Furthermore, stocks have always produced positive returns over a 20-year holding period.

CHART_Street-Smarts-080822

The outcome has been similar for bond investors, and investors with 50/50 stocks to bonds split.

Importantly, if left untouched, a $100,000 investment in the S&P 500 grew to $880,148 over 20 years, despite War, terrorism, inflation, the worst Recession since the Depression, and a pandemic. There were plenty of short periods where stocks did poorly, but clearly, those with a steady hand and long-term mindset have been significantly rewarded.

The Smart Play

Having a mindset that matches your temperament and time horizon is important. Too often, investors get distracted from their financial plans because of comments by others with different goals and styles.

If you’re a long-term investor, the S&P 500’s historical returns suggest making short-term decisions based on dueling bull and bear arguments might not be wise.

Instead, it’s best to keep short-term arguments in perspective, recognizing that in any given year, bulls or bears could be in charge, but over time, it’s paid to be an optimist. 

So, if you feel the news is swaying you from your path, step back and remind yourself of the reasons behind your financial plan. As long as those reasons remain intact, a do-nothing approach could be your best option.

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