October 13, 2015
What does Vanguard’s CEO, a portfolio manager, and an economist have in common? They all agree investors focus way too much on the short-term.
“Looking at investments in less than a 5 to 10 year window is time wasted. People should be thinking in 10-year increments around their portfolios because it’s really difficult to have any sense in the short-run what is going to happen.” Bill McNabb, Vanguard’s CEO
Short-termism refers to an excessive focus on short-term results at the expense of long-term interests. How do you define “short-term” in investing? My argument has always been that any money you intend to use in the next 5 years has no business being invested in the stock market. Examples include your emergency fund or savings towards a one-time expense such as a car or a house. At today’s low interest rates, you give up return for preservation of capital. However, you know with confidence that cash will be available when needed. Many investors now have the bulk of their savings in retirement accounts (IRA, 401k, and 403b). The beauty of these accounts is that their natural time horizons are very long-term in nature. Consider the 22-year old entering the work force who plans to retire at age 65. The “built-in” time horizon for his 401(k) is 43 years to retirement plus likely another 25-30 years during retirement. For a 22-year old, that’s a 70-year time horizon!
How about retirees or those close to retirement? Naturally, time horizons are shorter and strategies shift from wealth accumulation to distribution. This stage of life requires specific planning that helps investors stay focused on the long-term during retirement. Consider how much income you’ll need to meet a reasonable budget in retirement. Determine your sources of income outside of your portfolio such as part-time work, social security, and pension income. Finally, determine the amount of cash flow you’ll need from your portfolio to supplement your other sources of income. This exercise will help you develop an appropriate asset allocation (stocks vs. bonds) during retirement to fund your income needs. Although stocks are riskier assets than bonds and cash, you should not abandon stocks during retirement as they’ll help balance a portfolio, provide protection against inflation and have historically produced higher returns than bonds over a long periods of time.
A common investment strategy associated with short-termism is market timing; the strategy of making buy or sell decisions of financial assets (often stocks) by attempting to predict future market price movements. Market timers often buy and sell many times during the day and rarely are fully invested at all times. Consider the following example (see chart below):
- A 20-year investment in the S&P 500 Index between 1/3/1995 to 12/31/2014 produced an annualized return of 9.85%.
- If you engaged in market timing during this same time period and missed the 10 best days, your return dropped to 6.10%. For comparison, bonds returned 6.21% over that time period.
- Your return goes negative if you missed the 40 (out of 7,300) best days during this time period.
- Six of the 10 best days occurred within two weeks of the 10 worst days which can often be a time when investors are not fully invested.
Granted, investing is rarely this “easy,” but this is a great reminder to stay committed to a long-term strategy and portfolio asset allocation.
Source: JP Morgan
It seems that patience is becoming less of a virtue in today’s society. Consider some examples of short-termism:
- The average CEO tenure has decreased from about 10 years to about 5½ years since the 1990s.
- In a recent series of surveys of executives at large US firms, around 90% of managers reported pressure to meet earnings targets. Almost half of executives reported that they would reject a profitable project if taking the project meant missing short-term profit targets.
- The average tenure of a college football coach is now only 4 years, much like the experience of most college students themselves!
- Portfolio turnover has increased from 30% in the 1960s to 140% today. That means in the 60s portfolio managers would hold their stocks for roughly 3 years. Today, the hold time is much less as fund managers buy and sell their entire portfolio in less than a year on average.
- Household savings rates have dropped from 11.2% in 1959 to 4.6% today.
It’s important to understand how your portfolio is invested in order to align your objectives to meet a desired goal. Also, tracking performance is necessary in order to evaluate your progress towards achieving your goals. However, getting carried away with short-term movements in markets can de-rail a long-term plan. A more prudent course of action is to invest towards a defined goal, save consistently and maintain a long-term perspective.
Quarterly Market Review
Stocks fell sharply in the third quarter with emerging markets falling the most. Concerns over growth in China, falling commodity prices, a strong US dollar, and weak global growth increased volatility. A “phantom” interest rate hike from the Federal Reserve added to volatility as the global economy begins to adjust to tighter monetary policy from the United States. When the Fed actually hikes rates is anyone’s guess. What’s becoming evident is that the Fed has a tough task ahead as they begin to tighten amidst a slowing and much more volatile global economy.
The bond market posted mostly positive results with higher risk parts of the bond market like high yield declining in the quarter commensurate with other risk assets. The US dollar continues to strengthen, hurting commodities and those economies driven by commodity-based consumption.
A balanced portfolio of 60% stocks and 40% bonds has declined 5.2% during the quarter, but still has posted positive returns over the past 3, 5 and 10 year periods.
Masters in Business Podcast – An Interview with Bill McNabb. May 15, 2015. Available online at Bloomberg.com
Financial Times – Definition of short-termism. Available online at lexicon.ft.com
JP Morgan Guide to Retirement 2015 Edition. Available online at jpmorganfunds.com
The American CEO.com
A Wealth of Common Sense – Ben Carlson
St. Louis Federal Reserve FRED Economic Data – Personal Savings Rate Data. Available online at research.stlouisfed.org