There was a lot of talk from the news media, financial pundits, financial advisors, asset managers and others outside Wall Street calling for a big market selloff because of the election. Everyone had their reasons why it was a good idea to sell everything and go to cash; a blue wave, a contested election, Biden’s tax plan and on and on. Many people gave the same advice last election, and from the look of it, they were just as wrong with their advice for this election as they were the last. With that in mind, let’s review what the actual cost is of selling everything and going to cash, and being wrong, and just how impactful it is on the long-term growth of your portfolio.
Jason Zweig, at the Wall Street Journal, wrote this great piece, “Warren Buffett and the $300,000 Haircut” that discusses the power of compounding. In the article Warren explains that he never looked at $1 at its present worth, instead he always looked at what that $1 was worth compounded at a certain interest rate over time. Warren always looked at the future value of that $1 he could spend today. For example, if we pay $25 per haircut, every month, for the next 50 years instead of investing and earning 8% on that money, we are giving up $199,645.63 future dollars, if we pay that for 60 years, we are giving up $447,763.34 future dollars. Mr. Buffett’s haircuts were somewhere in between the cost and time frame of our example, but you get the point. This thinking exemplifies the brilliance of Warren Buffett, and it is really how we should all start viewing our money. It isn’t about what you are giving up today, it’s all about what you are giving up tomorrow!
The impact that bad investment decisions today, can have on your future dollars tomorrow.
Investors had a lot of opportunity to sell out of the markets prior to the election, maybe they sold at the beginning of the quarter, maybe they sold on November 2nd, no matter what date they chose, their decision was wrong, at least to this point. For analysis purposes let’s assume investors sold on November 2nd, from that date, every asset class we invest in for clients is up. A moderate risk portfolio consisting of 60% invested in SPY, an equity ETF that tracks the S&P 500, and 40% invested in AGG, a fixed income ETF that tracks investment grade bonds, is up 4.76%. By selling everything and going to cash on November 2nd, you have lost out on a 4.76% return, but is that really the extent of what you lost out on? The answer is definitively no, you lost out on much more. A $1,000,000 portfolio that went to cash on November 2nd would be worth $1,000,000 today, but if it stayed invested in our hypothetical 60/40 portfolio it would be worth $1,047,600 today. This is important because those starting values are really going to impact the future value of our portfolio.
As you can see from the table above, the future value of our mistake is much greater than the present value of our mistake, because of compounding. The longer the investment time period, the greater the loss from selling, or viewed another way, the greater the gain from staying invested. By staying invested we have $85,144.35 more in our portfolio after 10 years, over 20 years we have $152,659.65 more, and over 30 years we have $273,390.18 more. Statistically the market is more likely to rise than fall over time, if you are right and get out of the market before it falls, you also have to be right and get back in before it rises. The cost of being wrong on either of those decisions is great, even greater if we look at the true cost, which is the loss of future dollars. These decisions are irreversible and can only be made up by increasing equity allocations, which means taking more risk, or by saving more for retirement, or if we are already in retirement, by reducing our spending every year. We can also try and time the market again, waiting for that perfect trade, we just saw how risky that is though, are you willing to risk your future dollars on that?
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