You should ignore the noise regarding tariffs and (geo)politics and just stay the course. But for some, this may be a wake-up call as to why diversification is so important.
It’s been building for weeks but today I woke up to every investing sub on reddit flooded with concerns about what tariffs are going to do to the stock market. Some folks are so worked up that they are indulging fears that this may bring about the collapse of America and/or the global economy and speculating about how they should best respond by repositioning their investments. I don’t want to trivialize the gravity of current events, but that is exactly the kind of fear-based reaction that leads to poor investing outcomes. If you want to debate the merits and consequences of tariff policy, there’s plenty of frothy conversation on r/politics and r/economy. And if you want to ponder the decline of civilization, you can head over to r/economiccollapse or r/preppers. But for seasoned buy & hold index investors, the message is always the same: tune out the noise and stay the course. Without even getting into tariffs or geopolitics, here is some timeless wisdom to consider.
Jack Bogle: “Don’t just do something, stand there!”
Jack Bogle spent much of his life shouting as loud as he could to as many people as would listen that the best course of action for an investor is to buy and hold low-cost total market index funds and leave them alone until they are old enough to retire. It has to be repeated over and over because each time a new scary situation comes along, investors (especially newer ones) have a tendency to panic and want to get their money out of the market. Yet that is likely to be the worst possible decision you could make because market timing doesn’t work. Pulling some paraphrased nuggets out of The Little Book of Common Sense Investing:
- Most equity fund investors actually get lower returns than the funds they invest in.…. why? Counterproductive market timing and adverse fund selection. Most investors put money in as a fund is rising and pull money out as it is falling. Investors chase past performance.
- Instead, embrace market volatility with patience. Market downturns are inevitable, but reacting to them with panic selling can lead to poor outcomes. Bogle encourages investors to remain calm, keep a long-term view, and remember that volatility is a natural part of investing.
Bill Bernstein: “What I tell all engineers is to forget the math you've learned that's useful, devote all your time to now learning the history and the psychology. And one of the things that any stock analyst, any person who runs an analytic firm will tell you, because they really don't want to hire a finance major, they actually want philosophy and English and history majors working for them.”
My impression is that a lot of folks who are getting anxious about their long-term investments in the current climate may not know enough about world history and market history to appreciate the power of this philosophy. The buy & hold strategy works, and that is based on 100 - 150 years of US market data, and 125 - 400 years of global market data. What you find over that time is that a globally-diversified equities portfolio consistently delivers 5-8% real returns over the long run (eg 20-30 years). Can you fathom some of the situations that happened in that timeframe that make today’s worries look like a walk in the park?
If you’ll indulge me for a moment to zoom in on one particular period… take a look at a map of the world in 1910. The Japanese Empire controls the Pacific while the Russian Empire and Austro-Hungarian Empire control eastern Europe. The Ottoman Empire has most of “Arabia” and Africa is broadly drawn European colonies. In the decades that followed, these maps would be completely re-drawn twice. Russian and Chinese revolutions collapse the governments and cause total losses in markets and Austria-Hungary implodes. Superpowers clash and world capitals are destroyed as north of 100 million people die in subsequent wars in theaters across 6 continents.
The then up-and-coming United States is largely spared from destruction on home soil and would emerge as the dominant world power, but it wasn’t all roses and sunshine for a US investor. Consider:
- There was extreme rationing and able-bodied young men were drafted to war in 1917-18
- The 1919 flu kills 50 million people worldwide
- The stock market booms in the 1920’s and then crashed almost 90 % over the following years
- The US enters the Great Depression and unemployment approaches 25%
- The Dust Bowl ravages America’s crops and causes mass migration
- Hunger and poverty are rampant as folks wait on bread lines
- War breaks out, and again there are drafts and rationing
During this time, prospects could not have looked bleaker. Yet, if you could even survive all this, a global buy & hold investor would have done remarkably fine over 35 years. Interestingly, two of the countries which were largely destroyed by the end of this period - Germany and Japan - would later emerge as two of the strongest economies in the world over the next 35 years while the US had fairly mediocre stock returns.
The late 1960’-70’s in the US was another very bleak time with the Vietnam War (yet another draft), the oil crisis, high unemployment as manufacturing in today’s “Rust Belt” dies off to overseas competitors, and the worst inflation in US history hits. But unfortunately these cycles are to be expected.
“You need to know these bad things are coming. They will happen. They will hurt. But like blizzards in winter they should never be a surprise. And, unless you panic they won’t matter.
Market crashes are to be expected. What happened in 2008 was not something unheard of. It has happened before and it will happen again. And again. I’ve been investing for almost 40 years. In that time we’ve had:
- The great recession of 1974-75.
- The massive inflation of the late 1970s & early 1980. Raise your hand if you remember WIN buttons (Whip Inflation Now). Mortgage rates were pushing 20%. You could buy 10-year Treasuries paying 15%+.
- The now infamous 1979 Business Week cover: “The Death of Equities,” which, as it turned out, marked the coming of the greatest bull market of all time.
- The Crash of 1987. Biggest one-day drop in history. Brokers were, literally, on the window ledges and more than a couple took the leap.
- The recession of the early ’90s.
- The Tech Crash of the late ’90s.
- 9/11.
- And that little dust-up in 2008.
The market always recovers. Always. And, if someday it really doesn’t, no investment will be safe and none of this financial stuff will matter anyway.
In 1974 the Dow closed at 616*. At the end of 2014 it was 17,823*. Over that 40 year period (January 1975 – January 2015) the S&P 500 (a broader and more telling index) grew at an annualized rate of 11.9%** If you had invested $1,000 then it would have grown to $89,790*** as 2015 dawned. An impressive result through all those disasters above.
All you would have had to do is Toughen up and let it ride. Take a moment and let that sink in. This is the most important point I’ll be making today.
Everybody makes money when the market is rising. But what determines whether it will make you wealthy or leave you bleeding on the side of the road, is what you do during the times it is collapsing."
All this said, I do think many investors may be confronting for the first time something they may not have appropriately evaluated before, and that is country risk. As much as folks like to tell stories that the US market is indomitable based on trailing returns, or that owning big multi-national US companies is adequate international diversification, that is not entirely true. If your equity holdings are only US stocks, you are exposing yourself to undue risk that something unpleasant and previously unanticipated happens with the US politically or economically that could cause them to underperform. You also need to consider whether not having any bonds is the right choice for you if haven’t lived through major calamities before.
Consider Bill Bernstein again:
“the biggest psychological flaw, the mistake that people make, is being overconfident. Men are particularly bad at this. Testosterone does wonderful things for muscle mass, but it doesn't do much for judgment. And one of the mistakes that a lot of investors, and particularly men make, is thinking that they're able to tolerate stock market risk. They look at how maybe if they're lucky, they're aware of stock market history and they can see that yes, stocks can have these terrible losses. And they'll say, "Yeah, I'll see it through and I'll stay the course." But when the excrement really hits the ventilating system, they lose their discipline. And the analogy that I like to use is a piloting analogy, which is the difference between training for an airplane crash in the simulator and doing it for real. You're going to generally perform much better in a sim than you will when you actually are faced with a real control emergency in an airplane.”
And finally, the great nispirius from the Bogleheads forum: while making emotional decisions to re-allocate based on gut reaction to current events is a bad idea, maybe it’s A time to EVALUATE your jitters:
"When you're deciding what your risk tolerance is, it's not a tolerance for the number 10 or the number 15 or the number 25. It's not a tolerance for an "A" turning into a "+". It's a tolerance for accepting genuinely-scary, nothing-like-this-has-ever-happened-before, heralds-a-new-era news events…
What I'm saying is that this is a good time for evaluation. The risk is here. Don't exaggerate it--we all love drama, but reality is usually more boring than we expect. Don't brush it aside, look it in the eye as carefully as you can. And then look at how you really feel about it--not how you'd like to feel or how you think you're supposed to feel…If you feel that you are close to the edge of your risk tolerance right now, then you have too much in stocks. If you manage to tough it out and we get a calm spell, don't forget how you feel now and at least consider making an adjustment then."