Episode Transcript
Brenton: [00:00:00] For long term investors, it can sometimes be more beneficial to have a loss in your accounts than it would be to have the same positive return every single year.
And in this episode, I'll prove it to you. Let's get started.
Brenton: Hello, my name is Brenton Harrison of New Money, New Problems, and your host for the New Money, New Problems podcast. I hope you've enjoyed the last few episodes where we've talked about certain [00:01:00] investing principles, and I've been building you up, whether you knew it or not to this episode by starting with the value of saving money consistently, which is what we covered when we talked about dollar cost averaging. The premise being that if you put the same amount of money into the market every single month, you give yourself a higher opportunity to get the lowest average price of the investments that you're purchasing.
We also talked about risk tolerance and covered how, while there are periods where you don't want a ton of volatility, such as if you're a few years removed from having to make a large purchase or from retiring, there are also periods where just because the market goes down, You don't wanna run for the hills.
The example we gave is if you have 20 or 25 years until you need the money, you can't want to pull out of the market every single time your account goes down. And those were primer episodes for this one because in this episode I gave you a little bit of click bait. But it's true click bait that says, believe it or not, for long term investors, there can be benefits to periods where [00:02:00] the stock market goes down.
But we'll get to all of that information and I'll tell you where this came from. I've been doing YouTube videos for a number of years, and about a year or two ago, there was this period where there were all these financial hacks that were being shared on TikTok and Facebook and Instagram. And we did a series at that time where we talked about dispelling some of the media myths or money myths that you saw online, I'll put a link to that playlist so you can see some of them for yourself. We're gonna rerecord some of them in podcast format as well over the next coming weeks.
And in that series I pulled up a number of different social media posts that you saw online about the subject of the day, and one of the ones we did was the fallacy behind how people project their investment returns over a long period of time.
If you're following along with me on screen, you're looking at a tweet, which we've de-identified that says, and I quote, 'between the stimulus checks, three years of child tax credit and compound growth so [00:03:00] far, my kid will have an invested net worth of $10,000 by the end of 2021.' This was posted in 2020.
And I'm continuing, 'as long as it stays invested when he's 65, this $10,000 alone will be 5.4 million. His retirement is set and he is only 23 months old.'
Now this is wildly inaccurate, but I'll tell you where this comes from. Many times when you're trying to project how much you need to put aside for retirement or how much you should invest on a monthly basis, you use an investment calculator. And when you use an investment calculator, it asks you certain things like how much money you're starting with, but it also asks you what is the rate of return that your investment is going to receive over a period of time.
Now, the problem with this is you cannot know what the future investment return would be. I can promise you if I knew what the investment return was gonna be every single year on January 1, I would not be taking my time to do this podcast or working at [00:04:00] all. Instead, you have to either use certain things like what are called Montecarlo simulations, which is too complex for what we're gonna do today.
Or you can use the same return every single year, and that is what most investment projections do. Whatever return you put into the projection, it assumes you receive that same rate of return no matter what, every single year.
Well, that's not how the market works at all. But what many people repeat when they talk about the stock market is, Hey, over a 10 year period, if you just put your money in the stock market, it averages 8% or it averages 10%.
And it is true that over the history of the stock market, if you look at rolling 10 year periods, it may average eight or 10% or so. But if you're like me and you stumbled over those mean median mode lessons in school, you at least know that averaging a certain rate of return is not the same as receiving it every single year.
If I said that I have a [00:05:00] 5% static rate of return, I get a 5% return every single year, but a 5% average could mean that I got a 30% return in a banner year, and the next year followed it up with a 20% loss, but it still averages out to 5% average.
Static returns do not change. Average returns do, and the difference between the two can lead to wide gaps between an actual investment return.
If you're following along with us on screen, and we'll put a folder that has links to all of these pictures. What you're looking at on the screen is a table that shows you the returns of the s and p 500 from 2001 to 2010. And the reason that I picked this is this was one of the worst periods of returns in terms of rolling 10 years that you'll find for the stock market during that period of time.
In 2001, there was a loss of about 12%. In 2002, there was a loss of over 22%, and in [00:06:00] 2008 there was a loss of negative 37%. So there were some huge years in this market where there were losses that dragged down the average of the s and p 500 during this period.
And if you look at the actual return the. Average return over that 10 year period, it was 3.63%. And what we've done is we've assumed that a person put $10,000 in the market, starting in 2001. And we're gonna compare the return that they would receive if they got the average return, the way the market actually moved during that decade as compared to the consistent return where they get 3.63% every year.
And when you look at the results, the person who invests $10,000 and has it moved with the market, the way it actually moved during that decade starts with $10,000.
And in 2010, at the end of the year, they have $11,503 and 88 cents. Their money has gone up about [00:07:00] $1,500. But then if we look at the person who has $10,000 and gets a 3.63% return every single year, their money grows from 10,000 to $14,284 and 17 cents.
Now, that may not look like that big of a difference on screen. 14,200 to 11,500, but that amount is about 30% higher than what you get if you actually had that money in the market the way the market moves. And what this shows you is, even if you take one of the worst decades in recent memory and compare what the market actually did to putting a low but consistent return in an investment calculator, it leads to a large gap between the two numbers over just a decade. If you imagine then that you take an 8% return, which many people use when they're using these projections or a 10% return and project that over 20 or 30 years, You can have this person saying, just like the tweet that we covered, their son starts off with [00:08:00] a few thousand dollars and by the time he's 65, he would have 5.4 million. They are probably taking a really high return, plugging it into an investment calculator that assumes that return is received every single year and projecting it out over the course of six decades. And the result is it leads to a number that is likely wildly inaccurate. Why do I say it's wildly inaccurate? Because this person cannot possibly know what the return of the market will be over the course of the next 60 plus years.
Now, if it sounds like I'm being a Debbie Downer, I promise you I'm not, because what I'm trying to get across to you in the course of this episode is for the person who just puts $10,000 or $5,000 or insert whatever number here into the market and leaves it and does not continuously contribute, they will be on the wrong side of volatility in the market. I give this example all the time. I can't even remember if I've given it on this podcast, but if I give you a dollar and that dollar [00:09:00] is invested in the market and it loses 50% of its value, you have 50 cents left at the end of the year. But if in the next year it regains 50% of its value, most people would think you're right back to a dollar.
They say, Hey, you are down 50% one year, you're up 50% the next, you should have your dollar back, but you do not. You have 75 cents back, you have regained 50% of the 50 cents you have left. And the reason I give that illustration is because it drives home the point that when the market decreases, you have to put money in while the market is low to benefit from periods like what we saw in 2022. But if you don't put money in, it becomes harder and harder to recover from those drops in the market because you don't have any money going in to purchase the investment while the price is low.
That's why when you compare the consistent return to the one that had some drops, it's hard to keep pace. The consistent return never had that [00:10:00] period where it went down, whereas the person who actually experienced losses had it go down and never put money in to benefit from that period.
But if you can find a way to consistently contribute money to the market, even when it's losing money, that in the long run you can actually outpace an investor who receives the same return every single year.
I'll show you how after the break.
[00:11:00]
Brenton: Before the break, I intimated that there can be periods where a person who loses money but continuously contributes to the market can outpace the returns of a person who gets the same positive return every single year.
And that might have sounded crazy, but I'm gonna prove it to you.
What you now have on screen, if you're following along with us, and again, if you're listening, we'll put a link to all of these pictures in the show notes is a table that instead of showing you the returns from one of the worst periods in the s and p 500, which was [00:12:00] 2001 to 2010, we're now gonna look at one of the best periods in the market, 2011 to 2020.
I'm gonna give you kind of just rounded up or down returns, but in 2011, the return was 2% in 2012, 16% in 2013, 32% in 2014, 13.69%. It goes on and on. As a matter of fact, from 2011 to 2020, the only year that the market went down was 2018 where it lost 4.38%. So I thought this was a good opportunity to show you the difference between a consistent return where you get the same thing every year versus the return of an investor who experienced that drop in 2018.
So what we have on this spreadsheet is on the right, we have a person who gets what is the average of this 10 year period, which was 14.49%. We're gonna assume they get that every single year. There's no rising and falling, every single year they just get 14.49%. We're [00:13:00] gonna compare that to an investor who gets the 14.49% average by having money in the market the way that the market actually moved throughout that decade. But instead of doing what we initially did in our example, by giving them $10,000 and plopping it in the market and assuming that they never contributed again, we're gonna start them at $0 and we're going to assume that they contribute $500 every single month.
So they're starting from scratch, but they're gonna put money in no matter what. Now the person on the right, they get the benefit of having that consistent return of 14.49% every single year. And their $500 monthly contributions over a decade leads to at the end of 2020, a balance of $133,418 and 34 cents.
So $500 a month in a decade gives them over six figures in their account if they got the same return every year. Conversely, if we look at the person who puts 500 a month into the market, the [00:14:00] way that it actually moved, they get the highs where the money was going up and up and up. And then they had the loss in 2018 where the market went down a little less than 5%, but they were still putting in their $500.
And what you find is that at the end of that decade, as compared to the consistent return that had just over $133,000, our investor who had money in the real market, has a balance of $140,004 and 39 cents. They are a little under $7,000 above their peer, even though they had a year where they lost money.
Now there are a couple of reasons why this is the case. The first is the person who had the money, who got the same return every single year, gets the same return every single year of 14.49%. And while that's really strong, if they had their money in the market market, There would've been years where they surpassed that return.
As a matter of fact, in 2013, the market did 32%. In 2017, it did 21%. In [00:15:00] 2019 it did 31%. In 2020 it did 18%. So that would be one reason why they benefit from those actual larger years, and they would have more than what you would have in an investment projection. But the other reason is because in 2018 when the market went down, the prices of the investments they were purchasing went down as well, and it allowed them to take the same amount of money but buy more shares for that investment than they would've been able to had the price continuously climbed as it had throughout the rest of the decade.
So it's a small sample size, but hopefully it shows you the shortcomings of an investment projection, but also the wonderful power of dollar cost averaging and putting money into the market consistently and not worrying about the returns when you have one year or two years that seemingly knocks you off track. If you can focus on the habit, then in the long run, some of those years may be the best thing for your portfolio, even though it may not feel like it right now.
And that's [00:16:00] what I'm trying to teach you. I'm trying to teach you behavior. I'm trying to teach you logic. I'm also trying to teach you how to evaluate because again, there are periods where volatility is not helpful. And it is no fun to watch your money go up and down.
But if you pair the behavior of investing consistently with the knowledge of your risk tolerance so that in the long run you're not invested in something that does not meet where you need to be, then you can make sure that you're well positioned for future growth, even in spite of a negative return in the here and now.
[00:17:00]
