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A Look Back - 4 Investors Over 5 Years

The U.S. stock market has just completed an almost five-year bull market, finishing with not only its best year since 1997, but a startlingly wonderful month and final day of the year.  Despite all the uncertainties that we faced (the government shutdown, Boston bombings, the Syrian uprisings, debt ceiling debates, NSA revelations, the lingering economic aftershocks of superstorm Sandy, nuclear standoff with Iran) people will look back at 2013 as one of the most profitable years—but only for the disciplined and confident investor.

The actual realized lifetime returns earned by investors has far more to do with what they do than with the investments they select. In other words, investors are far more important than investments. For example, even if you are the best fund picker, if you were out of the market in 2013, this fund picking ability wouldn’t have made a lick of difference to your actual realized returns.

Two years ago, in my cover article of this newsletter titled “A Look Back”, I looked at the performance of several typical investors since the 2008 bear market had begun.  Now that it has been five years, I thought it was time to see how four of these investors have fared: Panicked Pete, Tim Timer, Nervous Nelly, and Disciplined Debby.

Each investor began January 1, 2009 with a portfolio value of $1 million dollars. Of this, 60% was invested in the Vanguard Total Stock Market Index, and 40% was invested in the Vanguard Total Bond Market Index. However, what each investor did during and after the market crash varied.

Let me introduce each investor and their strategy:

Looking Back on Four Investors (1/1/2009 - 12/31/2013)
  12/31/2013CumulativeAnnualby EachAccumulated
InvestorStrategyEnd ValueReturnReturnInvestorImprovement
Panicked PeteThrow In The Towel$1,150,00015.14%2.86%  
Tim TimerTime the Market$1,270,00027.32%4.95%$120,000$120,000
Nervous NellySell 1/2 of Equities$1,530,00052.99%8.88%$260,000$380,000
Disciplined DebbyStick to Plan & Rebalance$1,850,00085.15%13.11%$320,000$700,000
  • Panicked Pete determined that he couldn't take the market value drops in his portfolio. Therefore, he sold 100% of the Vanguard Total Stock Market Index in March of 2009 and placed the proceeds into his other less volatile fund, the Vanguard Total Bond Market Index. He was happy to be out (and stay out) of the equity markets until a time when he could buy lower. Unfortunately, that day still has yet to come.
  • Tim Timer was nervous, yet also quite confident in his abilities to move in and out of the stock market. He also moved 100% of his stock fund into his bond fund in March of 2009, but moved those dollars back one year later—unfortunately at a higher price. He again moved out of the market (like many) in December of 2012 due to fears of the impact of the fiscal cliff on the economy.
  • Nervous Nelly was anxious, yet not so confident in her timing abilities. She simply sold half of her equity allocation in March of 2009 moving the proceeds into her bond mutual fund. Like Panicked Pete, she is still waiting to get back into the market, but can’t bear buying back in at such “higher prices”.
  • Disciplined Debby had an investment plan (60% equity) and stuck to it by rebalancing her portfolio back to its target of 60% equity each quarter. This was very difficult as it required buying more equities in March 2009 when it appeared equities were forever dead. Debby tried to ignore the financial press and listened to her financial advisor.

Each of us are probably similar to one of these four hypothetical investors. Using software from Morningstar, we are able to calculate the returns of each investor over the last five years. 

Take a moment to review and reflect upon the returns actually realized by investor in the table below.  

As you can see, Panicked Pete’s portfolio ended with a value of $1,150,000 and a cumulative return of 15.14% over the last five years. This is an average annual return of 2.86%. Pete bailed out of equities at the bottom. Pete participated fully in the downside risk of the stock market, yet did not stay invested in order to achieve the expected returns.

Tim Timer did a little better with an ending portfolio value of $1,270,000. This is because Tim (while out of the market for a period of time) still participated in the equity returns from January 2010—December 2012. He also earned $120,000 more than Pete did over this time period.

Nervous Nelly let off some steam and retained half of her equities. As you can see, this was a far better strategy than either panicking entirely out of equities or attempting to time the market. However, she could have done better by sticking to her investment plan.
However, Disciplined Debby beat them all. Debby had no idea what the market would do over time. However, she had lived through enough market cycles to know that this time was likely NOT different. She had also learned that keeping to a plan is better than reacting emotionally to news. As a result Debby ended with a portfolio value of $1,850,000 for a cumulative return of almost 85.15%.  Her actual realized lifetime returns resulted in a portfolio that is $700,000 more than Pete’s, $580,000 more than Tim’s, and $320,000 more than Nelly’s.
Disciplined Debby is the only one of the four investors to manage her emotional responses to the news and market turmoil over the years. She had many reasons to “get out”, or switch her strategy. These reasons were not only the crisis’ themselves, but the social pressure to “do something”. However, she was able to stick to her guns because she had an investment strategy that included:

1. A Written Investment Policy Statement
2. An Asset Allocation Strategy
3. A Voice of Reason in Her Advisor
3. Ongoing Account Monitoring & Rebalancing
Naturally, this all can seem very easy in hindsight, whereas in real time it can be quite scary. However, we can look at the results time and time again and see that it is the disciplined investor that wins in the long-run.

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