I don’t want the spinach!—Doing what is right for exceptional investment performance

Timothy Brown |

I don’t want to eat the spinach. I don’t like it!I don't like it!

As a parent to a 4-year-old, I have heard this phrase often at the dinner table. Everything else on our daughter’s plate is eaten, except the spinach, salad, or broccoli. If it is healthy, it’s left behind and no coaxing will convince her to eat it.

In investing, we have a hard time eating the spinach because we don’t enjoy it (short-term negative returns) but we know it’s the healthy option for the long term. Let the markets work for you, not against you.

Let's Look at the Facts

I like to begin discussions with potential investors with the facts. How have capital markets delivered returns in the past? We have a book we call the “Returns Matrix” that shows the actual returns achieved by various asset classes over the last 20, 50, and 80 years. For finance types like myself, this is riveting material—like a “page turner” book you just can’t put down.

One question I often get is, “What is the right mix of investments for me, and how were the returns of different investments and asset classes over the last month, 3 months or 1 year? Whenever I get this question, I always ask the investors how their personal investments did. Most of the time they don’t know. They may know a ballpark of the actual dollars gained or lost, but not the percentages. If I am traveling from Toledo to Cincinnati, I want to know exactly how long it will take me to get there. The same should be known for the investments you are considering for your retirement and investment portfolio. How long will it take to get where I want to go?

Let’s look at the S&P 500. Consider all of the individual years of performance from 1929 to 2013. For instance, in 2013, the S&P 500 has earned 16%, but only 2.1% in 2011. Look at how the S&P performed every year from 1929 to 2013, and then look at every 2-year period, every 3-year period, 5-year period and 10-year period. While most of the 10-year periods were positive, from 2000 to 2009, the S&P earned a compound return of -0.9%, causing many to label it the “lost decade,” or the spinach.

But let’s move out a little to look at longer periods of time. The S&P 500 returns start looking more consistent and positive. Since 1929, the S&P 500 has earned a compound rate of return of 9.8% —the healthy benefits.

The longest period of negative returns occurred from 1929 to 1942. Over this 14-year period, the S&P 500 had a -1.0% compound return. Investing in the stock market has risks, and we discuss these with our clients so that they have a good understanding of expectations. It’s not what happens in the next year, or 2 years, 3 years, 5 years or even 10 years. What matters is what happens over the longer periods of time. Everything else is just noise, or the trees in the way of the great view. Over the long term, we have seen substantial positive returns in stocks.

An Appropriate Balance for Specific Goals

We will occasionally meet some investors who are uncomfortable with any negative returns. Fortunately, for these investors, there is one asset class that has never had negative returns—One Month U.S. Treasury Bills.

 Looking back at all of the annual returns since 1926, you can see there have been no negative returns.  We have a great chart that shows this visually. You can also see that the One Month Treasury returns since 1926 through 2012 have compounded at 3.5% per year. But, as you may be thinking, they haven’t done so well in more recent years:

 

2009: 0.1%

2010: 0.1%

2011: 0.0%

2012: 0.2%

 

That’s four years in a row where returns averaged less than 1%. If we go back in time, we see another four-year stretch from 1938 to 1941 that saw a 0% rate of return. We do not like to predict if or when rates will go up. The point is, we have seen periods of time where rates of return have been very low. Is it possible that rates could stay low for a longer period of time? Absolutely. But the trade off we’re helping clients make is avoiding negative returns.

On the positive side, from 1966 to 1982 (a 17-year period) One Month Treasury Bills compounded at a rate of 7.1% per year. Now compare that to the S&P 500 over that same 17-year period: a compound rate of 0.8%. While over the long term we’ve seen substantially higher returns from stocks, in this example the One Month Treasury bills outperformed stocks by a large margin.

While there have been lengthy periods of time that the S&P 500 has had negative returns, overall the S&P 500 has done better than the One Month Treasury bills, which we should expect.

So what is the right blend of stocks and bonds for you? It’s a combination that will work for your specific goals and objectives. Just remember that to some people, including my daughter Grace, the spinach doesn’t taste good in the short term, but the habit of healthy eating pays off over time.