Many investors view the stock market like a casino—put all your chips on red or black and hope for the best. Investors are seemingly obsessed with instant gratification after the internet and iPhone eliminated the need to wait for anything. This “what have you done for me lately” mindset is dangerous when it comes to achieving financial success. Long-term investment planning has taken a backseat to the cacophony of the market casino’s blare. Lifetime goals seem to have been replaced by capturing short-term returns that are measured not only every year but quarterly, monthly, weekly, or even daily. A massive amount of energy is spent by the mainstream media to intensify and focus attention on chasing returns to keep up with passive indexes. The acute attention on returns has created legions of investors who have a fear of missing out (FOMO) on the next bull market jump or a fear of not getting out (FONGO) before the next bear market crisis.
The Federal Reserve Board (the Fed) carefully curated an asset bubble post-Financial Crisis to boost consumer spending and drive an economic recovery. The Fed “put” or backstop has aided in the dysfunctional view many have of the markets. After markets swooned in December 2018, the Fed showed they are willing to flip-flop on their interest rate and quantitative tightening program to prevent the market from falling into a large (the 40% average) bear market correction.
Investors Are Losing to the House
The market’s run off the bottom in 2009 has been exhilarating. So why is this bull market so hated and underinvested by retail investors? The answer probably lies in what preceded this most recent bull cycle. The two brutal bear markets of 2000-2002 and 2008 may have permanently changed investors’ appetite for risk or loss. A recent study by J.P. Morgan covering the 20 years from 1999-2018 shows the S&P posted a return of 5.6% while the average investor* only captured 1.9% (Chart 1). How could the average investor fare so poorly? We believe the study confirms our experience, over the past four decades, of watching clients fail to “buy and hold” in the face of significant bear market losses of 20% or more. The conventional investment wisdom to build low-cost, diversified passive portfolios and to then “buy and hold” may be oddly out of sync with real investor behavior.
Investors’ dismal performance seems to center on this buy and hold advice that has been touted by the media and financial services industry for the past forty years. Investment Company Institute fund flow reports show investors flee markets during large market declines. We believe investors run when faced with normal market cycles that include large losses outside their risk tolerance. Investors don’t try to time the market. They are driven from the markets, bailing on their investment plans when losses exceed their tolerance level. Trying to follow the industry’s buy and hold mantra has led investors to “buy high and sell low” and then sit on the sidelines in cash. They often miss out on a good portion of early bull market returns that can be very powerful. Investors’ emotions leading to FOMO and FONGO can compromise a smart long-term investment plan. Let’s see how this could play out through the following examples.
Which Would You Choose?
Investment A has fully participated in the last ten years of bull market returns and is passive by nature, giving investors a fairly symmetrical profile to a major market index. Investment A has a year-to-date (YTD) return through June 2019 of approximately 19%. Investment B is designed to be more risk-averse, providing loss protection in down market trends and careful security selection. Investment B includes a blend of stocks and bonds and has a YTD return through June 2019 of approximately 2% net of fee.
Have the markets seduced you into chasing returns? Have you stepped inside the market casino, but are now confused? Then you may want to pause before determining your answer to the next question. Which investment would you choose? Your answer will probably depend on where you are on the FOMO-FONGO spectrum. Almost every investor I’ve ever met would choose Investment A with the higher return.
Decades of investment management experience have shown me that investing successfully is all about your capital and compounding efficiently, and it’s rarely about short-term performance. If we delve deeper into the performance properties of the two investments over the long term versus a short-term YTD focus, all should become clear. Spoiler alert: Investment A mirrors the S&P 500 Index, and Investment B is WBI’s conservative Retirement Income strategy.
From 2000 through 2018, which includes both bull and bear trends, the S&P 500 produced a 4.86% annualized rate of return. Table 1 shows drawdowns and return during the most volatile periods in this timeframe. It’s evident that to achieve the 4.86% return, investors holding S&P tracking products would have had to ignore a -43.75% max drawdown in the Dot-com bear market, a -45.80% drawdown in the Financial Crisis and a -13.52% drawdown in Q4 of 2018, based on quarterly calculation. Keep in mind, the most accurate view of index behavior is what you see on your tv screen daily. The S&P 500 had a drawdown of 19.36% in 2018, when calculated daily. Would you sit tight on your investment strategy if you lost almost half your invested capital—twice?
Meanwhile, the annualized net return of WBI Retirement Income from 2000-2018 is 5.41%. More importantly, investors took significantly less loss during market crises in this strategy. We feel investors are more likely to stay invested through a 15% loss over a 45% loss or more.
As it turns out, the Retirement Income strategy compounded much more efficiently over the long term by effectively curtailing losses, even though it has recently underperformed the S&P during the bull market trend. The short-term underperformance isn’t an oversight or a strategy fault—it is the result of active risk management that has raised cash to protect capital through recent volatility combined with a cautious stock selection process that evaluates securities based on value and momentum. Short-term mindsets will leave investors underwhelmed when markets are unstable. Advisors should comfort their clients by keeping focus on the long-term plan, rather than overthinking day-to-day gains and losses.
Do Not Forget About the Downside
We have found that when people think about the word “return,” the image conjured is always a positive number. This type of psychological bias ignores the fact that market returns have been negative 40% of the time historically from 1928-2017. The market also tends to fall twice as fast in bear markets than it rises in bull markets. By minimizing losses in bear market cycles, your portfolio can better maintain the capital needed to compound most effectively. Even the most well-designed portfolios cannot prevent investors from buying and folding on their strategy when losses can exceed 40% in bear markets.
Increase Your Odds for Success
Investors need to distinguish what they want from what they need. Over the short-term, if you are anything like me, you want your portfolio to perform as well or better than the markets. Over the long-term, your portfolio needs to consistently grow, so you have a large enough capital base to provide the necessary income to help fund retirement. The best investing practice requires an investor to set long-term goals and benchmarks as the design parameters of portfolio construction. A formalized investment plan can dramatically increase the probability of success. Advisors need to help their clients determine their “loss tolerance” and “required rate of return” to achieve their goals.
For more information on the WBI Bull|Bear Retirement Income SMA Strategy, click here.
Past performance does not guarantee future results. The views presented are those of Don Schreiber, Jr., and should not be construed as investment advice. Don Schreiber, Jr., Matt Schreiber, or clients of WBI may own stock discussed in this article. All economic and performance information is historical and not indicative of future results. This is not an offer to buy or sell any security. No security or strategy, including those referred to directly or indirectly, is suitable for all accounts or profitable all the time. Performance shown is composite performance which includes both Traditional and Tax-Smart Strategies. The Tax-Smart SMA program accounts are subject to investment risk, including the possible loss of principal. The ETFs in the Tax-Smart SMA program accounts may invest in other ETFs, mutual funds, and Exchange-Traded Notes (ETNs) which will subject the account to related additional expenses of each, and the risk of owning the underlying securities held by each. Investment risks may include but are not limited to: market, economic, political, interest rate, currency exchange, leverage, liquidity, credit quality, model, portfolio turnover, trading, REIT, high yield stocks, nondiversification, concentration, commodities, options, new fund, and client specific restrictions. WBI’s Passive ETFs are not actively managed and WBI does not attempt to take defensive positions in declining markets. You should not assume that any discussion or information provided here serves as a substitute for personalized investment advice from WBI or any other investment professional. If you have questions regarding the applicability of specific issues discussed to your individual situation, please consult with WBI or your chosen professional advisor. This information is compiled from sources believed to be reliable, accuracy cannot be guaranteed. WBI’s advisory operations, services, and fees are in the Form ADV, available upon request. The allocation to ETFs can provide increased tax efficiency over traditional SMA approaches. We believe the structure of the Tax Smart Program provides several benefits in addition to the potential for increased tax efficiency. However, Clients should understand that tax-qualified accounts, such as IRAs, do not benefit from any additional tax efficiencies of the “Tax-Smart” structure. Please consult with a tax professional prior to making investment decisions.
WBI has an inherent conflict of interest in investing in or recommending Affiliated ETFs as follows: 1) WBI and affiliates receive management fees from Affiliated ETFs. To avoid receiving two layers of management fees in situations where clients invest in Affiliated ETFs through SMA and Platform accounts, WBI will either: (i) waive the management fee at the account level; or (ii) credit the management fees paid by the Affiliated ETFs to WBI and its affiliates with respect to an account’s investments in Affiliated ETFs against the account-level advisory fees the account owes WBI, and 2) WBI’s affiliated broker-dealer, Millington Securities, Inc., receives compensation (including payment for order flow, commissions or other fees) for transactions effected on behalf of Affiliated ETFs. Trades WBI places through Millington will be subject to WBI’s duty of best execution and applicable law.
Net of Fee Performance (NFP) is net of WBI’s investment management fees and includes reinvestment of dividends and other earnings. Net returns reflect the deduction of the highest fee charged. Both NFP and Gross of Fee Performance (GFP) were restated effective February 28, 2017, to reflect the exclusion of management fees paid by the Affiliated ETFs to WBI held through the WBI Tax-Smart SMA program accounts which resulted in understating GFP, and as a result, NFP. Additional information is available upon request.
*Returns for average equity and fixed-income investors calculated by DALBAR. DALBAR uses data from the Investment Company Institute (ICI), Standard & Poor’s, Bloomberg Barclays Indices and proprietary sources to compare mutual fund investor returns to an appropriate set of benchmarks. The study utilizes mutual fund sales, redemptions and exchanges each month as the measure of investor behavior. These behaviors reflect the “average investor.” Based on this behavior, the analysis calculates the “average investor return” for various periods. These results are then compared to the returns of respective indexes. Ending values for the indexes and hypothetical equity and fixed-income investor investments are based on average annual total returns.
Performance shown is composite performance which includes both Traditional and Tax-Smart Strategies. Prior to 8/25/2014, the composite only included accounts invested in a model allocated to individual securities. On 8/25/2014, the composite added a second model of accounts invested in an allocation amongst Affiliated ETFs. The model implemented through the use of individual securities and all iterations of the models implemented through Affiliated ETFs are substantially similar. The Affiliated ETFs do not have performance history of comparable duration; therefore, performance of the models implemented through Affiliated ETFs could have been better or worse over the same period and is not indicative of future performance.
Benchmark performance does not include deductions of transaction and custodial charges or investment management fees, which would likely reduce performance results. Because the strategy involves active management of a potentially wide range of assets, no widely recognized benchmark is likely to represent performance of any managed account. WBI managed accounts may own assets and follow investment strategies which cause them to differ materially from the composition and performance of the benchmarks shown. Indices are unmanaged and may not be invested in directly.
Other strategies may have different results.
S&P 500 TR Index: includes a representative sample of large-cap U.S. companies in leading industries where all cash payouts (dividends) are reinvested automatically. Maximum Drawdown measures the peak‐to‐trough loss of an investment, indicating capital preservation.
ICI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any ICI data contained herein. This report is not approved, endorsed, or produced by ICI.
You are not permitted to publish, transmit, or otherwise reproduce this information, in whole or in part, in any format to any third party without the express written consent of WBI Investments, Inc.