(PUB) Investing 2015

ARE YOU AN INVESTOR who’s got some money to invest, but just can’t pull the trigger to put that money to work? Maybe it’s the headlines sur- rounding Greece and its potential exit from the Eurozone, or the bubble in Chinese stocks or the forthcoming increase in the fed funds rate—or maybe it’s my warning in the May issue of a Dow 16460—that has you in a holding pattern. I get it. Nobody wants to invest at a market peak only to see the markets start to fall right after, and their account with it. But, as I’ll show you, discipline and time in the market are powerful tools that every investor can use to overcome unlucky near-term results. Let’s compare two investors: Disciplined Dave and Hapless Harry. Both Dave and Harry invest $1,000 in 500 Index at the end of 1984, and invest an additional $1,000 in the fund each and every year for the next 30 years. Disciplined Dave simply adds his money on the last trading day every year. Hapless Harry tries to pick his spots, but he easily lays claim to having the worst timing in modern Wall Street history, and ends up add- ing his $1,000 at the fund’s highest price each calendar year. Obviously Disciplined Dave should have a lot more money at the end of 30 years than Hapless Harry, right? Well, Dave compounded his money at a 9.8% annual rate, turning his $31,000 into $176,671 at the end of 2014 (including his final contribution at the end of that year). Harry, despite his unfortunate timing, compounded his money at a 9.5% rate, and ended up with $167,835. To put this into context, 500 Index compounded at an 11.2% rate over this 30-year period. For all his bad luck—his timing could not have been any worse— Hapless Harry ended up with only $8,836, or 5%, less than Disciplined Dave. That’s the stock market. It gives, TIMING Don’t Fear a Top

did beat bonds, as GNMA ’s 7.2% growth rate trailed 500 Index’s 11.2%. (I used GNMA because Total Bond Market doesn’t quite have 30 years of history, having launched in 1986.) The short answer is that Wellington’s active managers have run circles around both stock and bond index funds. Balanced Index doesn’t have 30 years of history, but from its incep- tion in September 1992 through the end of 2014, the fund gained 495.1%. Wellington’s 701.2% gain over that stretch leaves Balanced Index in the dust and leads 500 Index’s 653.1% gain as well. So much for indexing beating active management. And if your concern lies entire- ly with investing in bonds, given today’s low yields, well, the differ- ence between Dave and Harry is almost indistinguishable. If Dave and Harry invested in GNMA instead of Wellington or 500 Index (again, I’m using GNMA because Total Bond Market hasn’t been around for three full decades), after 30 years of invest- ing Harry’s $88,040 would be just $365, or 0.4%, shy of Dave’s $88,406. The lesson I’m trying to get across is that timing isn’t everything. Even though every trade he made at a recent top (whether into 500 Index or Wellington) immediately lost money, Harry’s overall performance was simi- lar to Dave’s because Harry, like Dave, kept investing $1,000 every year. Harry also never panicked—he did not sell a single share. Finally, Harry had a long time horizon. The combination of his own discipline, consistency and ability to stay focused on the long run went a long way towards making up for unlucky timing. In reality, your luck can’t be as bad as Hapless Harry’s. If you are on the sidelines, take a lesson from Hapless Harry and make a plan to get in the game—as a long-term investor. The Model Portfolios on page 2 are a per- fect way to start. n

Discipline and Time Overcome Unlucky Timing

$200,000

Disciplined Dave Hapless Harry

$150,000

$100,000

$50,000

$0

12/84

12/87

12/90

12/93

12/96

12/99

12/02

12/05

12/08

12/11

12/14

takes back, and then gives some more. If you’re willing to ride out its inevi- table ups and downs, and can stay invested long enough, you almost always come out ahead. Of course, most investors do not allocate all of their savings, but own a balanced portfolio of stocks and bonds, which tend to act as shock absorbers when the markets get vola- tile. Today, of course, investors are not only grappling with headlines sug- gesting that stock markets are at risk, but also those telling them that bonds are no longer safe and that both stocks and bonds are overvalued. Let’s apply the same market-timing experiment we just walked through to a balanced portfolio. Let’s say Dave and Harry bought Wellington every year instead of 500 Index. At the end of 2014, Dave’s money compounded at a 9.9% annual rate over 30 years to $179,150. Harry wasn’t far behind, as his money grew at a 9.7% annual rate to $174,157—just $4,922, or less than 3% short of Dave. Yes, you are reading those numbers correctly: Both Dave and Harry did better investing in Wellington than they did in 500 Index. How does that happen if on average 35% to 40% of Wellington’s portfolio is in bonds, and stocks beat bonds over the long run? And over this 30-year stretch stocks

The Independent Adviser for Vanguard Investors • July 2015 • 7

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