In this episode, I discuss how our emotions impact our investing decisions when it comes to the stock markets and a though experiment to help you understand how to make your investing decisions.
More specifically, I discuss:
- With everything going on in the world, why would anyone still invest in the stock market?
- When fear and uncertainty are at a peak, how do I go about making investment decisions?
- Thought experiments to go through before making investment decisions
- What Crisis have we been through in recent history?
- What advances have we made in recent history?
- What really is “the stock market”?
- Factual data regarding the US stock market over the past several decades
Resources From This Episode:
The Key Moments In This Episode Are:
00:00:00 - The Current State of Affairs
00:01:26 - Reacting to Fear and Uncertainty
00:03:11 - Fears in Retirement
00:06:27 - Reflecting on Investment Goals
00:10:11 - The Role of Facts
00:14:53 - Probability of Positive Returns Over Time
00:16:14 - Importance of Best Days in the Stock Market
00:17:17 - Potential Downturns and Long-Term Returns
00:18:03 - Importance of Reevaluating Goals and Financial Plans
00:18:51 - Conclusion and Call to Action
“I don't trust our government. We are on the brink of another world war. Interest rates are making everything unaffordable, the stock market is going down, and everything is just getting more and more expensive. It feels like we are heading for a recession, and the world just seems to be crumbling before my eyes. Things are getting worse and worse, and investing is the last thing that I want to do.” If you share some of these thoughts, you're not alone, and here's what to do about it.
Hello everyone, and welcome back to the Retired-ish podcast. I'm your host, Cameron Valadez, certified financial planner. And today, I want to walk through the tough battle we are all going through when it comes to the world at large and how that affects our financial decision-making.
It's hard to decipher what information is wrong and what's right, what is a good decision, what will make for a bad decision, and when and how to react to what's going on. Today I want to lend a hand and provide you with a different perspective and a helpful exercise that may help you on your way. I want to warn you in advance that I may go a little deep in this episode regarding psychology and how we think about the world and investing and money.
By no means am I wanting you to necessarily agree with me. I simply want to provide you with a different perspective that you can do what you want with. So, it's 2023, and it seems that no matter where you look, there's nothing positive to find in the current environment when it comes to the global economy or finances in general. We live in a 24-hour news cycle world of breaking news and dire predictions. This leaves us with beaten-down expectations of the future, and eventually, our emotions take over and cause us to make changes to what we were doing before. Everywhere you look or read, and everyone you talk to seems to have the same consensus thoughts regarding the current chaos surrounding the U.S. government, the brink of another world war, interest rates making nearly everything unaffordable, the stock market going down, and everything getting more and more expensive, that a recession is inevitable, and things seem to be getting worse and worse.
So why on earth would anyone invest right now, especially in the stock markets? From a professional perspective, but also as a fellow human being and fellow investor, I understand many of the feelings, concerns, and thoughts you may currently have about the world at large. Believe it or not, I, as well as many other financial professionals, have similar fears and thoughts about the future and what to do about it as well.
People ought to feel this way. Otherwise, what would we be other than some emotionless robots carrying on each day like the last? The difference lies not in how we feel or what we believe but in how we react to those feelings and beliefs. Do we allow our emotions to take full control of us and cause us to react one way or another? Do we give ourselves time to drill deeper and understand the rationality behind our next decision? Or maybe some combination of both?
A compromise, maybe? Most of the fears I am referring to tend to consume the minds of those of you either near or in your retirement years since you likely have assets in your life's work of hard-earned savings and investments at stake. Let's not sugarcoat it. Some of the fears and beliefs of the future that we have actually do end up becoming a reality. And depending on what your biggest fears are, that may become problematic for you. Maybe not. However, no one has a crystal ball. And when I say no one, I mean no one. Not me, not the talking heads on TV, not the world-famous author, not the government, and not even the most world-renowned economists.
And because no one has that elusive crystal ball, how do we know if what's to come will end up hurting us financially or helping us achieve our goals and desires? In order to try and make sense of this, the first step in the process is to drill deeper into why we feel the way we do with our finances. If, for example, you are nervous about the U.S. government or a looming recession, try to determine what is the ultimate outcome. I am nervous about this. Sounds kind of funny, but it's actually very powerful.
As a common example, maybe you feel that if we were to go into the next recession, which, by the way, is a very normal thing, it's part of the business cycle, that it will be worse than ever before, and that your entire retirement nest egg will become worthless, leaving you with nothing, and you'll have to go back to work just to survive. While this is definitely a scary thought and would likely keep anyone up at night, try to go even deeper. Go through a small thought experiment of the reality of this happening to you, given your exact situation and financial plan, if you have one. Then to start, go back and try to remember why you began your investment journey in the first place.
What were your goals at the time? Why did you initially choose to invest in things like the stock markets or maybe real estate or whatever it is you have chosen to do with your money? How long of a time frame did you have to invest that money? Maybe one of your goals was to retire comfortably. At that time, you did your own research and due diligence, and maybe someone you trust shared their previous experiences with you and showed you that investing in these types of assets was some of the only ways proven throughout history that could allow your hard-earned money to grow above and beyond taxes and inflation in the long run.
You knew that these investments would fluctuate up and down over time, sometimes significantly, but understood that over the long run, they were likely going to be the most prudent way for you to reach your retirement goal. But in addition to investing in the stock market, you also set aside a few years' worth of cash or short-term bonds to help you weather any potential storm in the stock markets. Now, once you've reminded yourself of how and why you initially invested, you'll want to determine whether or not those goals have materially changed and not because of what's going on around you at any given moment. But what, if anything, has actually changed about what you want to try and achieve? If they have changed, maybe some change in how you invest is also warranted.
But if your goals are largely the same, maybe not so much. For example, when it comes to a retirement goal, sure, you're older now, and it may seem like you have less time to invest for that goal, but how long are you going to be in retirement? If you're in your early sixties and going to retire soon, you're likely to spend 20 to 30 years in retirement, which is a long time. Even when it comes to investing, your money will still need to outpace inflation and taxes over that time frame. However, maybe not all of your money should be invested according to that time frame.
If your goals haven't changed much, try to remember or look back to that time when you began your investment journey and see what was going on in the world and what was going on in your life. It may seem like there was much more good than bad happening compared to now, but there's a high likelihood that there was still plenty to be nervous and fearful about at that time as well. Just to give you an example and name a few, in the last 20 years or so, we've had one of the worst terrorist attacks on U.S. soil, the US invaded Iraq, the tech bubble burst in the stock market, we endured a great financial crisis, we've had multiple economic recessions, H1N1 was declared a global pandemic, then COVID-19 more recently, multiple devastating hurricanes have occurred, we've had some of the deadliest wildfires in recent history. Other countries have invaded each other, several banks have collapsed, inflation has reemerged, and the Oval Office has been blue and red.
That being said, there's a significant chance that some sort of crisis or apocalypse de jour was happening when you initially started your journey. And there, quite frankly, always will be. Believe it or not, even with all of the chaos surrounding us at all times, there's a lot of good news and positive things to look forward to when it comes to the world, your money, and your retirement. Just imagine for a second that someone was able to go back in time 20 years or so and tell you what was coming up in the near future, and you learned of all of the crises that lie ahead. Would you have started investing at the time?
I bet not. You probably wouldn't have touched the stock market with a ten-foot pole. But by looking at any chart of the stock market over the last 20 years, it's easy to see that not investing would have been the biggest mistake you could possibly make. So why did the stock market still go up even though we faced such adversity? Well, think about the good that has come along as time has passed.
To name a few, over that same 20 years or so, we made it through each and every recession. We had the birth of homeland security. The Internet was invented. The iPhone and other smartphones were invented. 3D printing is now a thing. We have transportation via companies like Uber and Lyft at nearly all times in nearly every town. The cloud was invented. We can pay for things by waving a watch. Electric vehicles are here. Some of us can work from home, we have better medicine, people are living longer, Social Security and Medicare are still around, and we are now learning how to use AI to better our lives. All of the things I just mentioned have largely made our lives better and or easier.
But on top of that, these things we are fortunate to have improve faster and at a greater scale than any time before in history. And the main reason for this is because of the capitalist society we live in. Because of innovation and competition, we are able to make incredible advances such as those I just mentioned. Why do I bring this up? It is simply a reminder that while the world will never be perfect, there is plenty to be optimistic about, even when it seems as if nothing can get any better.
And yes, I know some of you may wish we could return to when times were less complex. But in general, the world has much more opportunity, and most people tend to lead better lives today versus in the past. I also bring this up because there will be several times during your investing lifetime when you will be heavily inclined to make certain investing decisions based on the current state of emotions. And the only thing you will have to fall back on to make those decisions is history because we know that no one can consistently predict the future. So now comes the part of the process where we eventually have to refer to the facts because we need facts to have some basis for our decisions.
Rather than simply telling you that something like the stock market typically goes back up over time, let me explain that phenomenon a little bit differently. The reason the overall US stock market has generally prevailed through thick and thin is because the stock market represents the companies and the hardworking people that make up those companies that caused a lot of the change and innovation we have seen and continue to see.
When you invest in the stock market, you are purchasing ownership in those very companies, albeit typically a very small amount of ownership. The issue is that most people see the stock market as a vicious bag of snakes that moves up and down like crazy every single day versus what it really is, which is ownership in the world's biggest, strongest, most cash-rich, innovative, and profitable companies on the planet. Most of these companies, but not all, make it through whatever economic downturn, geopolitical, and financial crisis comes their way because of their ability to adapt and because of the fact that they continue to innovate and change the world. In turn, they typically earn more money over time, becoming more profitable, and thus their value increases over long periods of time.
However, all along the way, there will always be a new reason in the news each and every day that may cause the value of that particular company to rise or fall that day. That is what we call noise, and reacting day to day, month to month, or even within a year or two is called trading, not investing. Unless you were in the business of flipping houses, would you set off to invest in a rental property just to get rid of it, depending on how its value moved over the next three months? Not likely. Stocks are much of the same in that aspect, but emotionally they are hard to hold because you are able to see their current value almost 24/7.
Another way to look at this is that if you were to be having a casual conversation with your friend who has a 401(k) plan, let's say through their job and has been participating in it for 25 years or so. And they were to ask you what you do with your investments. And you reply along the lines of I invest in the world's largest and most profitable companies. They would likely be inclined to ask you what you mean by that and how you are able to do so. To which, of course, you would hopefully reply, saying that you invest some portion of your money in a diversified portfolio of stocks.
They then would typically look at you with utter confusion because they quickly realize that they are likely doing the exact same thing. The key is that they don't see it that way or never really thought of it that way, but that's what they are really doing. So now, let's end this decision-making experiment with some factual data about the stock market to help back up this phenomenon, which I will also include in the episode show notes.
The value of the largest 500 or so companies in the United States, represented by the S&P 500 Index, has been cut in half, so down 50% three times in the last 50 years. That same index stands today roughly 35 times higher than it was at the beginning of that time frame because the earnings of those companies have grown that much over that time period.
According to Bloomberg, in an analysis done by Dalbar, from December 31, 1992, to December 31, 2022, the 30-year annualized returns of U.S. stocks have been about 9.6%, inflation about 2.5%, and the average investor about 4.1%. So why does the average investor fare worse than the very thing that they invest in? Well, it's because of emotional decision-making at exactly the wrong times.
According to more data from Bloomberg, looking at the same S&P 500 Index, which again is essentially the largest 500 or so companies in the United States from 1937 to the end of the third quarter in 2023, the probability of positive returns over a three-year period was 87.7%. 93% over a five-year period and 97.4% over a ten-year period. In fact, they were positive 77% of the time over any one-year period, which is still incredibly high. From January 1, 1992, to January 1, 2023, if you missed only the ten single best days in the stock market, you would have missed out on around a 3% annualized return per year. If you missed the 50 best days over that entire 30-year period, you made a little more than 0%, which is astounding. What's more astounding is that of the 30 best days in the stock market since 1992, five of them occurred during the tech bubble in the early two thousands, and eleven of them occurred during the Great Financial Crisis.
The lesson here, of course, is that no one ever knows when the best days will occur, but oftentimes they are right after the worst days or during what seems like the worst of times, which is typically when our emotions are at their peak and we are in panic mode. Each year, there is the potential for the market to experience a significant downturn, which for the S&P 500 has averaged approximately 14% since 1980. That means that even in years where the stock market boasted phenomenal positive returns at some point during the year, it has been down as far as 14% on average over that time frame.
To sum this up, the problem with trying to make investment decisions based on our current emotions, or what you think will happen at any given time, is that you often miss out on significant positive returns. Missing even the ten best days in the stock market in the last 30 years reduces returns meaningfully.
I'm not saying to always assume that your particular investments will eventually work wonders for you or not to worry about what's going on in the world around you. You definitely should. Rather, I encourage you to revisit your why and take extra time to truly understand your situation, your goals, and your financial plan before reacting to what's going on around you. Even during times of extreme uncertainty and turmoil, don't throw the concept of investing in the stock markets in the trash, as it is usually much bigger than the current noise around you. Looking at all this, it's my belief that being an optimist is the only thing that squares with all of history. In addition, it tends to lead to a happier and more fulfilling life as well.
If you have trouble understanding how to invest, given your circumstances, or feel that you need some sort of financial plan to keep you on track for your goals, feel free to reach out to us at retiredishpodcast.com or email us at email@example.com.
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