Equity Market Primer and Overview of Common Investor Mistakes

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1 Equity Market Primer and Overview of Common Investor Mistakes A. Kip Pazol, Chief Investment Officer and Director of Research September 2015 INTRODUCTION Investors often negatively affect their own returns, and in doing so, never receive market-level returns on their intended equity allocation. Evidence is shown in the following data from Dalbar s Quantitative Analysis of Investor Behavior: Source: Dalbar, Standard & Poor's 1

2 I. Long-Term VS Short-Term Risk on Returns Empirical data shows that long-term investment risk associated with equities is overstated by most investors. Vacillations of short-term, normal business cycles should not be the main concern of longterm investors. However, what does matter is any long-term impact resulting from short-term cyclical volatility on the average growth rate of real cash earnings after the business cycles have time to stabilize. This is a rare occurrence. In fact, the data below shows that over 10-year rolling periods going back to 1965, investors have realized negative returns only twice (or 4% of the time). Source: JT Stratford, NYU Stern School of Business, Standard & Poor's, FactSet Furthermore, data suggests that in the U.S., 10 year periods have been long enough for the economic cycles to even out. Even if invested at the former market peak during October of 2007, an investor s portfolio would still be up approximately 48% after factoring in dividends (Source: FactSet). 2

3 II. On Volatility Another problem seems to be that investors are unaware of what to expect from market volatility. Over the last 50 years, volatility in market returns (as shown by standard deviation), has measured around 15%. In other words, if we assume a 10% average total return on equities, we will typically see the following observations concerning the effect of standard deviation on returns: Source: JT Stratford, Standard & Poor s The chart demonstrates that, during an average year, 68% (one standard deviation) of market returns can be expected to vary between -5% and 25%. Furthermore, 95% (two standard deviations) of the time, returns can reasonably be expected between -20% and 40%. The important concept to understand from this is that, more often than not, returns will be positive. 3

4 III. Market Timing A high Risk Bet Warren Buffett once said, If you think you can dance in and out of securities in a way that defeats the inflation tax, I could like to be your broker but not your partner. In this quote, Mr. Buffett refers to inflation itself as a tax and would seek to reap trade commissions from the investor. Moreover, the market itself has further costs beyond inflation and trade costs that negatively affect short-term traders. That price is the opportunity cost of missing the best days in a market. This is further demonstrated in the graph below: Source: Lipper It becomes apparent through this graph that missing just a few key days will cause investor returns to drop by 40% of their maximum potential and even turn negative after just 40 days. Therefore, it is important to remember to avoid market timing and instead focus on the long-term. 4

5 Investors who cannot master their emotions are illsuited to profit from their investment process -Benjamin Graham A process, by definition, is a series of steps taken over a period of time to achieve a particular result. The investment process can be very challenging at times and it can definitely exercise an investor s patience. At JT Stratford, our Disciplined Approach to investing is an important concept because it emphasizes our adherence to our investment process regardless of any short-term volatility. Investing done well is a long and often boring process, but a very rewarding one. For further information on our investment process and philosophy, please contact us. JT Stratford, LLC, is an SEC Registered Investment Advisory Firm that provides investment management and employee benefits to individuals, corporations, and institutions throughout the Southeast. Since its founding in 1995, the firm has held an established reputation of trust based on a deep knowledge base and a disciplined approach to investing. JT STRATFORD, LLC 211 Forrest Ave Gainesville, GA (770) customerservice@jtstratford.com Securities offered through Triad Advisors, Inc. Member FINRA/SIPC Investment Advisory Services offered through JT Stratford, LLC 5