Have you noticed that the financial Cassandras are out in droves, sounding shrill warnings of imminent disaster? They say you're delusional if you believe we're in an economic recovery. Or, you'd better liquidate right now unless you're prepared to get flattened in yet another stock market crash that promises to be worse than the last. Even the Wall Street Journal's relatively staid columnist Brett Arends penned an article titled, "May's big selloff could be just the beginning." It's an unsettling read.
Achieving serenity in turmoil
Let's take a deep breath and gain some insights from a recent Vanguard study. Ommmm.
The study divides the investment community into three predominant types and examines investor attitudes about equity risk over time.
Roughly one-third, or 31 percent, of stock market investors fall in the "overconfident investor" category. They believe the stock market "always" outperforms safe investments such as Treasuries over a set period of time. Four in 10, or 42 percent, equity investors are "measured investors" who believe stocks "generally" beat safe investments over time. Both overconfident and measured investors are advocates of the "time diversification" theory, which argues that the longer you hold a diversified stock portfolio, the more likely it will generate a positive return that outpaces safe investments.
Just 18 percent are "skeptical investors," those who see equities as inherently risky no matter how long they're held. These investors tend to have either very little financial experience or a lot of experience, and they're disproportionately female. Their expectations about future stock market returns are lower than that of other investors, and 30 percent agree or strongly agree that the "risks of stocks are not worth taking."
A matter of perspective
Perhaps overconfident investors are looking at numbers differently than skeptical investors. The study points out that during the 1926-2009 time frame, the stock market's best year was 1933, when it rose 54 percent. Its worst year was 1931, when it fell 43 percent. That's nearly a 100 percentage point difference. But when you look at longer periods, the results seem smoother. Over the best 20-year period, 1979-1998, stocks returned 17 percent annually on average. During the worst 20-year period, 1929-1948, they returned about 3 percent a year on average. The difference between best and worst is 14 percentage points, much less than 100 percentage points.
But the study points out that skeptical investors look at how the returns would impact a given dollar amount. For instance, a $10,000 investment would have grown to more than $239,000 during that best 20-year period, but only to $18,000 during the worst 20-year period. "Viewed from this standpoint, the difference between best and worst wealth outcomes is a factor of 13," say the study's authors, lending credence to the skeptic's outlook that rather than decreasing, risk increases with time.
OK, I confess that I lean more toward skepticism than overconfidence. What about you? Are you overconfident, a measured investor or a skeptical one?