New York Yankees baseball legend Yogi Berra once quipped, “Baseball is 90% mental. The other half is physical.” There’s little doubt that the mental game is important for baseball players, but for investors, controlling emotions is crucial. One way we as investors can help control our mental game is to recognize that how we receive information can significantly affect our decisions. Behavioral economists Richard Thaler and Shlomo Benartzi, who refer to this behavior as “framing dependence,” found that when people were shown a historical sample of actual annual returns, they allocated just 40% of their portfolios to stocks; however, when people were shown a sample of 25-year returns (from the same S&P 500 database), they chose to invest 90% of their portfolios in stocks. Based on these and other similar results, experts suggest that investors evaluate financial news flow consistent with their investment time horizon—long-term investors should avoid constantly re-evaluating their portfolios. For those investors unable to avoid the temptation to regularly check their portfolios, professionals suggest that they treat the short-term movements as merely statistical noise and stay away from over-reacting in response.
The S&P 500 gained in 67 of the past 91 years (1926 – 2016), which is not surprising, because the compound annual growth rate of the S&P 500 (total return, including both dividends and capital appreciation) is about 10%. However, it’s the 24 years of negative annual returns that sometimes frighten investors. With all the ups and downs, viewing annual stock market returns may lead investors to feel as though they are on a wild ride. Long-term investors, however, might take comfort in viewing the stock market from a long-run perspective. Examining all 72 twenty-year holding periods since 1926, we find that the S&P 500 did not decline in a single one. Over this 91-year period, the lowest 20-year annualized return (starting in 1929) was 3.1%, which could be expected because this period included the Great Depression. The highest 20-year annualized return of almost 18% started in 1980, when stocks were cheap.
My updated analysis (included on our website), Retirement Nest Eggs … Withdrawal Rates and Fund Sustainability, provides added support for long-term thinking and valuable withdrawal rate guidance for retirees. In this study I found that a hypothetical stock investor almost always has a greater portfolio ending value after 20 years of retirement withdrawals than either a Treasury-bill or long-term bond investor, and he also has a much lower probability of depleting his nest egg. Assuming 5% annual inflation-adjusted nest egg withdrawals, I found that a stock investor (based on S&P 500 returns 1926 – 2016) would have depleted his nest egg in only 6 out of 72 twenty-year retirement periods. An investor in Treasury bills would have depleted his nest egg in 19 out of 72 years, over three times as often as the equity investor. Two conclusions can be drawn from this analysis: (1) Investors should view their retirement portfolios with a long-run lens; and (2) they should focus on equities to help build their nest eggs and ensure they are not prematurely depleted.