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Plan Well, Retire Well

Saving and investing your money

Investor asks, Is this all I get for doing everything right?

After a recent workshop on investing, one participant came up to ask this question:

"My investments are diversified, I've paid attention to my asset allocation, and I stuck with my investments through the craziness of 2000 as well as 2008-2009. And I'm barely breaking even! Is this all I get for supposedly doing everything right for the past ten years?"

You may identify with this individual's sentiments. You're thinking, "I played by the rules; now where's my 10% per year return?"

I contend that you did get a reward for playing by the rules. It's just not the reward you were expecting. My response:

"Your reward for doing everything right is that you're no worse off than you are."

And here's my thinking:

The reward for choosing an appropriate asset allocation:

Being able to stick with your investments through the downturns implies that your asset allocation was appropriate.

Many people decided that stocks could only go up after seeing the gains of the 80s and 90s. As a result, they underestimated the risk of being too heavily invested in stocks; they failed to rebalance and, as stock values grew and grew, stocks represented greater and greater proportions of the investors' portfolios, exposing them to more and more market risk. In 2000 and again in 2008-2009, those individuals likely had portfolios that were too risky for them, making them more likely to panic at the bottom, sell, and lock in those losses. Then, they missed out on the opportunity to recover from those losses over the last year or so. The value of their investments might still be down significantly, perhaps 30% to 40% if they were invested almost entirely in stocks and sold all of them close to the market bottom.

But because you had an appropriate asset allocation for your risk tolerance/capacity, you held steady through all these ups and downand are now back to even. Being "even" is the reward, and it's not insignificant compared to the alternative.

The reward for being diversified:

To be blunt, the reward here is that you didn't permanently lose some of your investments. What if you'd had 20% of your money in General Motors before it filed bankruptcy? That investment would have become worthless. What if you'd been heavily invested in oil companies at the time of BP's Gulf oil spill? BP stock dropped 50% after the spill. Would you have had the nerve to hang on through that, or would you have sold? Being diversified would have moderated the impacts of both those events on your portfolio, allowing you to be "even" now instead of having a loss.

The reward for rebalancing, or continuing to invest:

The rewards for following these standard investment strategies over the past ten years would be more obvious. Rebalancing forces you to buy (or buy more) of those asset classes that have dropped as a proportion of your total portfolio. Rebalancing would therefore have led you to buy stocks when the market was down, allowing you to reap even more benefit when the market rebounded.

Dollar cost averaging means you would have continued to invest the same dollar amount each month or each payday; when the market was low, you would have been purchasing twice as many shares of your chosen stock mutual fund as you were at the market highs, bringing down your average cost per share and increasing your potential gains.

The last ten years have been a harsh reminder that there are no guarantees in investing. That's why you 1) never invest money you're going to need in the next 3-5 years, 2) maintain an emergency fund, and 3) allocate your money across different asset classes and diversify within those asset classes.

Sometimes, like the 1990s, following those guidelines meant that you made less on your investments than those who put everything in the stock market. Other times, like the last ten years, it means that you did no better than those who were 100% in bonds and cash. But if you maintained that middle-of-the-road investment strategy throughout those 20 years, you kept yourself in a position to benefit from good markets and to protect yourself from bad ones. Consider yourself bruised but not beaten, not as wealthy as you'd like but not as poor as you could have been.

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