Understanding the Investment Landscape

On May 6, 1954, Roger Bannister became the first person in history to run a mile in under 4 minutes.  Roger cut it close; his time was 3 minutes and 59.4 seconds, but he did it, proving doubters wrong.  

For thousands of years of recorded history, it was considered impossible for an athlete to run a 4 minute mile.  The “experts” claimed that the human body was not designed to be that fast.  Yet, after Roger proved that it was possible, 300 more athletes accomplished the same feat in the next 10 years.

In fact, according to Wikipedia, Roger attained his record, “with minimal training, while practicing as a junior doctor”.  Further, his record lasted just 46 days.  

Why?  Why after thousands of years of belief that a sub-4-minute mile was impossible, was this feat replicated in just 46 days?  Why, in the span of 10 short years, were 300 runners able to do “the impossible”?

I believe that it is because Bannister’s accomplishment broke down the barriers in other athletes minds.  Nobody in the running world thought it was physically possible to run the mile in under 4 minutes, therefore, nobody attempted it.  The limit was not in the athlete’s body, but in their mind.

What does this story have to do with investing?  A lot.  What you believe matters in life, including what you believe about investing.  The problem is that most people don’t know what they believe so they chase investments that are doing well, which often leads to poor performance over time.  

The chart below is the result of a survey by Dalbar that is published annually.   I have been looking at this chart for decades and, while this data is published every year, the results look roughly the same today as they did 20 years ago.  

What you see above, is the 20-year total returns of the major asset classes in which people can invest.  

On the far left, the graph shows that, from 2001-2020, the best performing asset class was REITS or Real Estate Investment Trusts, which returned 10.0% per year.  Next was EM Equity (EM= Emerging Market), followed by small cap (small company) stocks, High Yield, S&P 500 and so on.  

If you look at the orange bar on the right, you will see that the average investor earned 2.9% per year which barely outpaced inflation.   

The average investor owns a portfolio made up of stocks (which averaged 7.5%), bonds (4.8%), some foreign stocks (5.0%-9.9%), REITS (10%) and small cap stocks (8.7%).  How is it possible that the average investor underperformed everything they tend to invest in, including home prices?

I think that the answer comes down to what investors believe.  Many believe that they have to own the best investments over the last 1,2 or 3 years, so they invest these assets.  This is called “performance chasing”. Often, performance chasing leads investors to buy an asset class after the juice is already squeezed from the orange.  When they invest, they may get a short period of performance, then sit for long periods of time earning very little, grow impatient, and chase the next hot investment idea, restarting the cycle.  This is repeated over and over and it often leads to very poor returns.

How poor?  If you had $100,000 invested in 2001 in the light blue bar, which is a portfolio made up of 60% stocks and 40% bonds, it returned 6.4% per year for 20 years, while the average investor earned 2.9%.  Below is the difference in portfolio value after 20 years:

As you can see, performance chasing and now knowing how to invest or investing without a plan often leads to very poor results. 

There are a lot of investment philosophies that work over time, but none of them work all the time.  To succeed at investing, one must look seriously at these philosophies, pick the one that best matches their internal beliefs, and then exercise patience.  You must know (and accept) going int that there should be periods of both good and poor performance.  

With your investments, behavior is everything and your behavior is driven by what you believe.  The bottom line is that poor beliefs equal poor decisions which equal poor results.  

When it came to running, Roger Bannister knew what he could do and what he wanted and set that as his target.  Investing is similar.  While the investment world is complex with a lot of competing voices and philosophies, one must know what they believe, what it takes to get to their goal, commit to one strategy and then exercise patience.  

The investment landscape is complicated.  If you need assistance making sense of your investments, we’re here to help.