Author: Rick Hill
It takes only a glance at Dimensional Fund Advisors’ 2018 market summary to recognize global markets didn’t leave anyone applauding in the end. The volatility put the popular press in a tizzy (with no certainty on what lies ahead). Not surprisingly, our response has been to double down on our perspective on how to maintain “unruffled serenity” in volatile markets.
For example, in our fourth quarter client letter, we revisited an important, annually updated Dimensional chart depicting yearly market premiums since 1928. We’ve shared similar charts before, but it remains worth repeating whenever the going gets tough. As we wrote in our letter, “No one complains when they finish the year with stock returns much higher than average, but the typical investor has a hard time handling a big down year.”
We share an excerpt from our client letter today, hoping we can help you, too, Take the Long View®.
Unruffled Serenity and Taking the Long View
Why would an investor want to accept wild, short-term swings in the markets? Because investors are paid for enduring those swings. It’s that simple and that hard.
Because stocks ended 2018 with a series of dramatic gyrations, we decided to illustrate just how normal these big market movements really are. The following chart, which shows the annual performance of the U.S. stock market since 1928, illustrates why it’s worth maintaining a long view and disciplined investment strategy.
The blue bars indicate years in which the broad U.S. market delivered an average return above T-bills (i.e., a positive premium). The dark blue bars indicate years when a positive equity premium was within a 2% range of its long-term average (represented by the dotted black line). On the other side, the red bars indicate years in which the market underperformed T-bills (i.e., a negative premium).
The first thing to notice is that on average, the annual market premium has been strongly positive and there have been more years of overperformance than underperformance. But in any given year, the U.S. market premium has varied widely—sometimes producing extreme positive or negative performance relative to T-bills. It’s worth repeating: The premium has been within 2 percentage points of the long-term annual average in only four years since 1928.
As savvy long view investors, we know that if we want a long-term average annual premium from the equity portion of our portfolios we have to expect and endure returns in any given year that are wildly above or below that average. No one complains when they finish the year with stock returns much higher than average, but the typical investor has a hard time handling a big down year. What separates us is knowing that we win over the long run by embracing this volatility. We win because in the boring math of investing, the long-term owner of global capitalism is likely to end up in the top decile of all investors. It’s simple, but it ain’t easy. Maybe we should call it a serenity premium?
We frequently mention the importance of employing global diversification to manage investment risks while pursuing expected returns. The broad concept is simple: Don’t put all your eggs in one basket.
That said, beyond the simple adage, questions may remain. A recent Dimensional Fund Advisors paper addressed one of them: Since U.S. stocks have outperformed international and emerging markets stocks over the last several years, is it still worthwhile to invest worldwide?
If you’d rather skip to the compelling conclusion, the short answer is, yes, global diversification is still worth it. Not only do the last several years tell us nothing about the next several years, they could lull U.S. investors into a false sense of home-biased complacency. To emphasize this point, we need only point to the 2000–2009 “lost decade,” when the S&P 500 took a depressing 10-year dive, while most of the world’s indexes soared.
Bottom line: You never know where your next source of best returns will be found, so it’s best to go global – and stay that way.
While I just turned 76 last week, my 80th birthday doesn’t feel that far off. I couldn’t have asked for a better role model on how to prepare for that milestone than Chris Crowley, octogenarian and best-selling author of the Younger Next Year book series.*
Earlier this month, we were delighted to host a special evening with Crowley (84) and a gathering of friends and family at St. Louis’ PALM Integrated Health venue. In his featured book at the event, Crowley shared seven tips on how to “Live Strong, Fit and Sexy — Until You’re 80 and Beyond.” He and his co-author Dr. Henry Lodge suggest this is “all” you have to do:
- Exercise six days a week for the rest of your life.
- Do serious aerobic exercise four days a week for the rest of your life.
- Do serious strength training, with weights, two days a week for the rest of your life.
- Spend less than you make.
- Quit eating crap!
- Connect and commit.
Okay, I’m on it!
*To our clients – Shoot us an email if you’d like your own copy of Younger Next Year.