Stock markets are unpredictable...
Analysts predicted the markets would slide the Monday following the terrorist attacks in Paris. They didn't...
The S&P 500 rose 1.5% that Monday. And the story was similar in financial markets around the world.
Or consider pharmaceutical giant Pfizer's announcement last month that it will buy Allergan – the maker of Botox – for $160 billion. This merger will make Pfizer, which is based in the U.S., the largest drugmaker in the world. The deal also allows Pfizer to move its headquarters to Ireland, saving – according to some experts – more than $1 billion in taxes.
While more than $1 billion in savings sounds positive... naturally shares of Pfizer and Allergan fell around 3% after the announcement. (Both stocks eventually recovered those losses.)
The point is... it's impossible to digest what every new headline will mean for the market's day-to-day movements.
Unfortunately, too many investors worry about every small market movement, up or down. That's why last month, we told you how to keep "negative panic" from your portfolio.
Today, we're telling you how to increase your portfolio's profits – no matter what's going on in the markets – with our "do-nothing" strategy.
The two main components of this strategy are:
Don't get scared out of the market.
Stay invested in stocks.
But we're not talking about just any stocks. We mean real companies with real earnings that make up a part of the real economy.
From 1928 through 2014, stocks returned an average of about 11.5% per year, according to Federal Reserve data. The 10-year Treasury bond returned just 5.3% annually in the same time period.
That might not sound like much...
But it means $100 invested in stocks in 1928 would have compounded into nearly $290,000 today. The same $100 invested in Treasury bonds would be worth less than $7,000.
Stocks consistently deliver the highest returns over long periods of time. The problem is that stocks can be risky. You never know what they'll do in the short term.
A research firm called DALBAR tracks what individual investors actually earn on their stock investments. Over the past 30 years, the average investor has earned just 3.7% a year... compared with 11.1% for a simple buy-and-hold of the S&P 500 Index.
That difference comes down to timing. The "average" investor consistently gets in and out of the market at the wrong time.
Many people used the turbulent economy and market of 2008 as an excuse to sell their portfolios, bury their heads in the sand, and stop investing in the market entirely.
Those folks missed out on the opportunity of a lifetime to secure their retirement. More than likely, they sold at the bottom... and they won't get back in until the top...
All you have to do to beat the "average" investor is to just stop trying.
Let your hard-earned money work for you... A simple, diversified, buy-and-hold strategy will earn much more than 3.7% over the long term.
Behavioral economist Richard Thaler, now known for his books Nudge and Misbehaving, wrote a defining paper on the "equity premium puzzle" in 1985...
His conclusion was that folks' ability to tolerate stock-market risk was inversely proportional to how frequently they checked in on performance. And, according to Thaler, "For someone with a twenty-year investment horizon, the psychic costs of evaluating the portfolio annually are 5.1% per year." Thaler later suggested investing heavily in stocks but avoiding all stock-market news – especially cable television.
And in a recent study, Fidelity Investments analyzed client accounts to see who had the best performance. The highest-earning group was those who actually forgot they had investment accounts at Fidelity.
Anyone who reads a newspaper or watches financial news regularly is always going to have a reason to get out of the market. Don't be one of them.
Two Great Books by Richard Thaler
If you're looking for a book to read over the holidays, or just want to expand your knowledge of behavioral economics and the psychology of decision-making, my managing editor just recommended two books by Richard Thaler: Nudge: Improving Decisions About Health, Wealth, and Happiness and Misbehaving: The Making of Behavioral Economics.
What We're Reading...
- Time, not timing, is key to investing success.
- Vanguard's gain is Wall Street's pain... The company known for do-nothing passive funds is saving investors billions in fees per year.
- Something different: The CEO who's paying everyone $70,000 has something to hide.