I have a guest post up today on Frugal Rules that you should definitely check out. But now, back to your regularly scheduled programming…
I love investing. Ever since I got the itch about 4.5 years ago, I’ve wanted to learn more and more. I read books. I read blogs. I read journal articles. I make up spreadsheets to test assumptions. Basically I’m a huge nerd. And while I’ve come to enjoy learning about all aspects of personal finance, from insurance to estate planning, investing remains my true love.
But let me tell you a secret. In contrast to the popular opinion of what an investor “in the know” looks like, I have no idea what the stock market is doing today. I have no idea what it did yesterday. I have only the vaguest idea of what it’s done for the last month or so.
So if I truly love investing, why couldn’t I tell you even this basic information? Because it doesn’t matter. It just doesn’t matter.
The stock market movements are important, but…
Let me start off by saying that I don’t ignore the stock market because the movements are unimportant. I’ve written before that the general market movements have a significant effect on our personal investment performance, no matter how we’re actually invested. Research actually shows that as much as 75% of our returns are derived from the returns of the general markets. That’s crazy!
Those numbers would seem to advocate for spending a great deal of time worrying about the daily market movements. After all, if that’s the factor primarily driving our returns, shouldn’t we care an awful lot about it? That’s certainly what the media would have you believe, with its regular updates on how the various stock markets are doing right now, have done in the past day, or what the experts think they will do in the coming days and weeks. And it’s certainly what many financial experts would like you to believe, as each tries to position him or herself as the one person who can help you navigate these turbulent waters.
But the fact of the matter is that focusing on the daily ups and downs of the market doesn’t get you any closer to reaching your financial goals. In fact, it’s more likely to cause you to make mistakes than it is to make you money, with the additional cost of added stress.
It’s the long term that matters
Let’s start with the obvious. Some days the market is up. Some days it is down. Sometimes it’s up or down by a lot, sometimes just a little. But it’s always moving. These short-term movements can be scary, and on the really bad days it might feel like we’re losing control of our financial goals. But there are two realities about these daily fluctuations that we need to take to heart:
1. We cannot control them.
2. They are temporary.
That first point is so important. No matter how much we try, we cannot control the market movements and we cannot predict how they will move. Trying to do either is a waste of time and will lose you money over the long run. But you can control your exposure to the market movements through your asset allocation. Picking a mix of investments that is either more aggressive or more conservative will determine just how much those movements affect your money. But this is a long-term decision based on your risk tolerance and desire for returns, not a knee-jerk reaction to what the markets are doing today.
It’s also important to understand that daily, weekly, monthly and even yearly returns are simply snapshots in time. They do not represent long-term trends. They are temporary, much like an unusually hot day in the middle of winter is simply one day of many, not representative of what all future days will look like. Trying to react to or infer larger meaning from these day-to-day changes is not only pointless, but it is harmful.
One of my favorite examples of this comes from one of my favorite investing blogs, Canadian Couch Potato. He shows that while historical long-term stock market returns are around 8.5%, the annual returns almost never fall near that long-term average. In fact, about 67% of the time the annual return is at least 10 percentage points higher or lower than that long term average. If you tried to make long-term conclusions based on the returns from any single year, those conclusions would most likely be wildly wrong.
It’s the long-term trends that we care about, and those have been consistently strong for many decades. Short-term movements tell us nothing about what to expect going forward.
My plan doesn’t have anything to do with short-term movements
A little while back I outlined my personal investment plan. Basically, I have four mutual funds representing four different asset classes. Those asset classes were picked because of their long-term characteristics, and I plan to keep the allocation between those asset classes stable for my entire life. The only real fidgeting that happens comes when I add new money, or when the market movements cause my allocation to get out of whack and I have to rebalance.
Nowhere in my plan is there any mention of reacting to the day-to-day stock market movements. They weren’t part of how I chose my investments, and they aren’t part of my ongoing management. They simply aren’t relevant. So why would I pay attention to something that has no bearing on my plans?
We’re often told that we need to stay “in tune” to the markets if we want to be successful with investing. Honestly, this couldn’t be further from the truth. Successful investing involves a strong understanding of the long-term characteristics of different asset classes. It involves constructing a portfolio that takes advantage of these long-term characteristics to capture a desired level of return at a reasonable level of risk. It involves contributing money regularly and sticking with your plan through the ups and downs.
If someone asks me what I think of the stock market right now, I’ll be honest and tell them I don’t even know what it’s doing. And even if I do know, I have no thoughts. It just isn’t important.