Sally’s next door neighbor and good friend Robert Rischi is the typical stock junky. He, like Sally, is also 60 years old and has been investing $1,000 per month for retirement for the last 15 years, ever since his 45th birthday. However, in stark contrast to Sally, he surrendered to the siren call of the mutual fund and investment industry and has been allocating all of his savings to the equity market. Mind you, to maintain a diversified equity portfolio, he has allocated 75% to a broad collection of Canadian equity funds, with the remaining 25% going into broadly diversified U.S. equity funds. In the language of financial planning 101, he has been dollar-cost averaging into the stock market, buying more units when prices are low and less when prices where high. He has been careful to stay away from the high-cost mutual funds and concentrated bets on particular industries. After all, his RRSP isn’t meant for gambling.
Oh yes, Robert has endured some sleepless nights and restless days over the last few years, and especially the last 18 months; but he has been steadfast in his belief that over the long run the extra market volatility and financial stress will pay off with a handsome nest egg. In the language of financial economists, he is riding the equity premium. In fact, he periodically teases his neighbor Sally about her overly cautious retirement account, and has promised to invite her to his paradise retirement home in the Caribbean.
And, after 15 years of investing his portfolio is worth $221,150 at the end of March 2009.
Yes, you read that correctly, for all the risk Sally shunned, the equity premium she missed and the teasing she endured, she is actually ahead and has approximately $17,000 more money than Robert, after 15 years of investing. Oh, and if Robert had allocated 100% of his portfolio to Canadian stocks, he would have had $243,200 which is more than his cross border 25/75 portfolio. So much for international diversification.
Now, wait a minute, you might cry: “What exactly was Robert holding all these years? You are cherry picking!” Well, I assumed Robert was holding typical funds linked to Canadian and US Equity indices, on which he was paying (only) 100 basis points of expenses each year. If Robert was paying closer to 200 basis points in annual fees, his nest egg would be worth $202,000, which is $37,850 less than Sally. And, if you believe that the end of March/2009 isn’t a fair ending point, consider the end-of-December/2008 values: Sally has $234,500 while “Buy and Hold” Robert has $226,500.
So, what exactly went wrong?
It seems an entire generation of Canadians has been unlucky, or perhaps confused by the buy-and-hold mantra. Over the long run all this stress was supposed to pay-off with handsome rewards. Sally was supposed to look back with regret, at retirement, since Robert would be so far ahead. This has clearly not been the case and only time will tell – perhaps when Robert is 70 or 80 – if indeed his nest egg will ever surpass Sally’s by a wide enough margin to make it all worth his while.
Take Away
I am quite sure that most Canadian financial planners would never advise Robert to allocate 100% of his RRSP to equities, Canadian or international. Perhaps the portfolio would have been tempered with some asset allocation to bonds and other classes. The possibilities are endless and indeed, some alternative Roberts might be ahead of Sally. However, many others who have been buying and selling for the last 20 years have ended with much worse account values than all of the above-mentioned scenarios. They bet on performance that never materialized. And honestly now, beating Sally isn’t much of an achievement when you consider the little skill that requires.
Indeed, I believe that your equity allocation should depend much less on your so-called time horizon, hard-to-measure risk aversion or fickle confidence in the stock market, and much more on the composition and structure of your personal balance sheet. If your job is reasonably secure, your pension is protected and you income is predictable, then go ahead and take some stock market risk with the non-essential funds. Thus, I personally am still very heavily allocated to equities/stocks because I have a secure job with a Defined Benefit (DB) pension from the University. Economists call this general asset class human capital, which is likely more valuable than financial capital.
So, here is the bottom line. The long-run can be very long indeed. The financial planning theories we have used to quantify the “probability of regret” from equity investing must be revised after the new statistical evidence we have uncovered during the past year. The potential rewards must be tempered. To loosely paraphrase one of the greatest economists of our time, Professor Paul Samuelson, the long-run case for equities shouldn’t be oversold.
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Love this post... Excellent!
That was witten in May 2009, the markets up a lot today perhaps 40%, Nov 2009 , If only you the author could have told us what would be the best investment to make back then - maybe now you can tell? The whole purpose of investing in equities is the probablitiy of losing out to Bonds over a long term (20 yeras say) is almost zero - so are you going to invest in Bonds in the hopes thae rarest of chances you actually win? And even in your case here..how much did the bond saver actually win over the stock guy? Anfd now today in Nov 2009, he's $100,000 ahead of the Bond guy...good article, by a guy who "works" for the government!
Seems a bit unfair to the best-practice buy and hold investor:
1) as you note, portfolio is extremely unbalanced and undiversified with only highly correlated US and Canadian equities
2) market bottom - in retrospect,you picked the bottom - Robert's portfolio would be considerably more today (Sept 09) than in March
3) time horizon - by definition, if he has a long time horizon, he still has a long time horizon, so it isn't time to compare results; it doesn't matter who is ahead after the first period or the second period but at the end of the game that matters
I think the take away is first that you had better be sure how long your time horizon really is (10, 20, 30 years?), and second, recognize that what you think is your time horizon may not actually be so - e.g. retirement starts earlier than you thought because of job loss, need for funds for higher priority medical expenses that bring forward your time horizon.
