Why Stock Buybacks are Significant and What to Make of Recent Trends

Company stock buybacks recently surpassed 2007’s prior record of $172 billion. As of the first quarter 2018, buybacks from the S&P 500 Index constituents reached $178 billion, up about 34% year-over-year. This compares with $24 billion in stock buybacks at the market bottom in 2009.

As the name implies, stock buybacks (also known as share repurchase programs) happen when companies buy back their own shares. A firm uses its cash position to repurchase company stock either in the open market or directly from select shareholders. These programs reduce the number of shares outstanding for the company in question and thus increase the ownership stakes of its remaining shareholders. The end result is more profits or earnings per share (EPS) per shareholder.

In general, stock buyback programs are viewed favorably by Wall Street. These programs help neutralize shareholder dilution that comes from excessive stock option issuance. Many management teams go further and announce buyback programs that more than offsets dilution from stock options.  In these cases, existing shareholders see their ownership stakes grow, and with it, their portion of earnings per share.

Another positive attribute of share buybacks is their affect on key company financial metrics such as earnings per share (EPS), return on equity (ROE), and earnings growth rates. These ratios are used by professional investors to determine the health of a company and are usually part of their investment decision process. Because share buybacks often boost a company’s financial profile, these programs can lead to more interest among institutional investors and thus increased demand for the stock. Higher demand from large investors typically translates into a higher stock price. With higher ownership stakes and larger earnings per share accruing to remaining investors, stock buybacks offer shareholders a compelling, two-fold benefit.

Investor perception also plays a significant role in share buybacks. Many argue that because a company’s management team has inside information regarding a firm’s growth prospects, a share buyback announcement is a signal that a stock may be undervalued – otherwise management would choose to spend the company’s cash on more profitable investments. This positive signal alone can cause a stock’s price to rise.

There is a downside to share buybacks, however. In recent years, record-low interest rates have prompted many companies to issue large amounts of debt to fund their share buyback programs. While this has had the effect of boosting near-term earnings growth and increasing existing shareholders’ ownership stakes, it could come at the cost of longer-term returns. Although interest rates remain low, as yields increase- debt servicing costs are likely to rise. These higher debt burdens – taken on to buyback company shares – could crimp a company’s ability to invest in value-enhancing initiatives such as technology investments or new manufacturing facilities, and ultimately reduce long-term earnings and cash flow growth.

Likewise, stock buybacks are a more flexible alternative than issuing a dividend. Many contend that management teams prefer share repurchase programs to dividend payments because they can easily suspend buyback activity with limited negative ramifications. In contrast, dividend cuts are viewed quite unfavorably by investors and are likely to significantly pressure a stock price. When a company issues a new dividend it suggests confidence in the firm’s market position, growth prospects, and cash flows. Thus, when dividends are cut or eliminated it signals deteriorating company fundamentals ahead.

Given the short-term benefits and minimal near-term risks associated with share buybacks, more companies are engaging in these programs than ever. Similar to individual investments, repurchase programs are most beneficial when a management team buys its firm’s stock at low levels and watches it appreciate in value over time. Although the investing principle of buy low and sell high is well understood, many corporate directors fail to follow this basic rule of thumb. The historical record indicates that seasoned company management teams are just as likely to buy at peak valuation levels and refrain from share buyback programs at market bottoms.

Although company management teams have a poor track record when it comes to timing share buyback programs, many are excellent stewards of their firm’s growth prospects and market positions. This suggests that as individual investors we would do best to focus on high-quality investments with long-term track records of delivering value and leave the market timing to speculators.

Carrie Tallman, CFP®, CFA™
Guest Contributor 
Share this:

Stocks on Sale

U.S. stocks have already seen two pullbacks greater than 5% so far in 2018, as measured by the S&P 500 Index. That compares to only one pullback over 5% in the last 2 years. To say that recent stock swings have been jarring would be an understatement. While sharp declines in prices are unpleasant, equity volatility has been unusually low since the Financial Crisis ended in 2009. Unprecedented support from the Federal Reserve coupled with steady economic growth has pushed stocks steadily higher for 9 years.

As a result, investors have gotten used to smooth and steady stock market gains. But our experience since 2009, in which the S&P 500 Index declined 5% or more only 10 times, is not the norm. Going back to 1945, on average the S&P 500 Index has experienced declines of 5% or more every six months – almost double the frequency of pullbacks we’ve had since the Financial Crisis. While the recent past has been a pleasant ride, market volatility is likely to increase going forward, which may not be a bad thing.

A friend of mine and savvy stock investor once told me that she loved market pullbacks. “It’s like a sale,” she said, “…an opportunity to buy quality products at discounted prices!” Her analogy stuck with me over the years and today I view market pullbacks as opportunities rather than a reason to panic.  Granted, training my brain to think this way took some time and effort. But as an investor, it is an endeavor worth pursuing.

Consulting firm, Dalbar, provides an excellent reason to re-frame your thinking regarding market pullbacks. According to their research, while the S&P 500 Index has delivered an annualized trailing 10-year return of 6.95% through 2016, the average investor return was just 3.64%! Even more striking, the average investor earned a 4% annualized return over the trailing 30-year period compared with the S&P 500 Index’s 10% annualized return for the same period!

As the data clearly indicates and as Dalbar notes, “Investment returns are more dependent on investor behavior than fund performance.” These well-below market returns happen because investors tend to sell their stocks (and bonds) as prices are falling or bottoming. Instead of buying low and selling high – the tried and true way to grow wealth – a lack of investment discipline causes many retail investors to do just the opposite. To compound matters, after selling their stocks and funds during market downturns, many investors – scared from the market turbulence – typically sit on the sidelines as markets recover and therefore never recoup their portfolio losses.

While not all market declines present perfect buying opportunities, falling asset prices do present a chance to add to positions at lower prices. Stocks (and bonds) are on sale! Sometimes downturns are longer and more severe than we would like or expect. However, timing the market is a losing game. Research suggests that taking a long-term approach to investing, regularly rebalancing your portfolio to an appropriate target allocation, and staying invested through market downturns significantly increases the odds that you reach your long-term financial goals.

Weathering market turbulence is not for the faint of heart – which is why a financial advisor can be such a valuable asset. During turbulent market environments your advisor will guide you through market downturns, rebalance your portfolio to take advantage of lower prices, and ultimately remind you why you’re invested. On that note, we’re grateful you’re our client!

Share this:

Bear Market Anniversary Reflections

March 9th marked the 9 year anniversary of the most recent bear market bottom. It passed quietly with no bands playing and no flags flying. For those who endured the decline, it was a stressful experience that tested the mettle of all of us as investors. The market peaked in October 2007, and then the S & P 500 index of large-company US stocks fell 37% in 2008. Stocks continued to fall in early 2009, until the market finally bottomed on March 9th.  Overall, there was about a 57% decline in the S & P 500 from peak to trough, the magnitude of which no one had seen since the Great Depression. Although the length of the decline was in line with the post-World War II average for a bear market at 17 months, it seemed like it would never end. After hitting the bottom on March 9, 2009, the market recovered sharply and closed up 26.5% for the year. It is interesting to note that despite these declines, the calendar years 2007 and 2009 were both positive for stocks. All declines, while distressing at the time, have proven temporary.

2017 marked the 9th positive year in a row for stocks. While we remain optimistic about the economy, we recognize that eventually there will be another negative year or years. There’s just no way to predict exactly when these will occur. Fortunately, all the major declines in modern history have been short-lived, typically lasting 2-3 years. In the past 92 years, 1929-32 was the only consecutive 4 year down period for stocks. 1973-74 was a 2 year decline, and 2000-02 was a 3 year decline.

If you don’t know when the declines are going to come, what can an investor do to maximize their chances of success?

Make sure you have an appropriate asset allocation (mix of stocks, bonds and cash) that suits your individual risk tolerance and spending needs. You should keep enough cash to provide for emergencies (we typically recommend 3-12 months of after-tax living expenses) and enough fixed income to serve a source of spending when stock prices are lower. While bonds are not particularly attractive right now with interest rates likely to rise from here, you will be glad you have them to help weather the periodic declines that historically are short-lived.

-Avoid making dramatic changes to your portfolio based on news headlines or the mood of the day.  The sudden “I’ve got a feeling” moves in to or out of the market, with a large portion of your portfolio are what can really hurt investors.

Focus on portfolio income. Dividend income from the stocks in your portfolio should be higher each year since more companies will increase their dividends than cut them. Many S & P 500 companies have histories of consecutive dividend increases of 25 years or more, with some over 60 years.

Understand how much you are spending, including what is discretionary and what is not.  The household spending level is the hardest question for most people to answer as we are updating their financial plans. If you are a Parsec client, take advantage of our eMoney portal to get a better idea of your spending by linking your credit cards and bank accounts. Access to the eMoney portal is included at no additional cost to Parsec clients.

Once you have a good grasp of your expenses, periodically monitor your spending level in relation to your portfolio income and investment assets, and adjust if needed.

Historically, the stock market has many more up years than down years. The key is having an appropriate asset allocation, not making dramatic changes to your portfolio based on the mood of the day, and periodically rebalancing to your target mix (which forces the discipline to buy low and sell high).

 

Bill Hansen, CFA

President and Chief Investment Officer

Share this:

What a Rising Rate Environment Could Mean for Bond Funds

After the yield on the 10-year U.S. Treasury Bond – a widely used economic bell weather – bottomed in July 2016, interest rates have risen substantially through March of this year.  The recent upward pressure on yields has pushed bond prices lower.  Strong economic growth, ongoing interest rate hikes from the Federal Reserve, and recent political developments could mean higher yields ahead.  Given the current environment, we’d like to take a closer look at bonds and bond funds.  We’ll examine how they work, a key risk metric to consider, and how these investments might perform if interest rates continue to rise.

Bonds are a type of fixed income investment given the regular cash flows a bondholder receives.  Similar to your home mortgage but with the roles reversed, investors who own bonds are loaning money to an entity (usually a corporation or a government) in exchange for a variable or fixed interest rate over a specified period of time.  This interest rate is known as the bond coupon and it varies based on the credit worthiness of the entity and the length of the payback period, among other factors.

While a bond’s coupon rate, or its stated yield at issuance, remains fixed for the life of the bond its price or value on the open market will vary based on prevailing interest rates.  When interest rates rise, bond prices fall, and when interest rates fall, bond prices rise.

How sensitive a bond’s price is to a change in interest rates is measured by a term called duration.  Specifically, duration is a measure of interest rate risk.  It indicates how much a bond’s principal value will rise or fall due to a change in interest rates.  Measured in years, a bond or bond fund with a higher duration will be more sensitive to changes in interest rates than a lower duration bond or bond fund.  As a result, a portfolio of bonds with a higher duration will fall more in price as interest rates rise than a portfolio with a lower duration, all else being equal.  Fortunately, bond mutual funds or ETFs report their portfolio duration and investors can use this metric to gauge short-term risk.

I say short-term risk because while a jump in interest rates – as we’ve seen recently – will weigh on a bond fund’s near-term performance, the higher current income that comes as a result of an increase in interest rates will often offset much of the decline in a bond fund’s value over the long-term.  This is one benefit of owning multiple bonds or a fixed income fund versus an individual bond.  Because a portfolio of bonds or a bond fund doesn’t have a single maturity date (instead it contains many bonds with different maturity dates), it can provide more income flexibility.  For example, in a rising rate environment, as some bonds in the portfolio mature, the manager can reinvest proceeds from those securities into new bonds that now have higher yields.  In turn, this pushes the portfolio’s yield up and helps to offset price declines.  In particular, bond funds can offer significant diversification benefits given their exposure to many individual bonds with different durations and credit profiles often for a low fee.

While a bond fund’s duration will indicate how much it declines (or rises) in price when interest rates rise (or fall) over a given period, it also indicates how much of a boost it will get from new, higher yields.  Bond funds with higher durations – which are more sensitive to interest rates – typically offer higher current yields to compensate for their higher risk profiles.  So while bond portfolios with higher durations will experience sharper price declines when interest rates rise, they’re also more likely to benefit from higher current income over the long-term.  At the same time, bond funds with shorter duration – which are less sensitive to interest rate changes – won’t benefit as much from higher current income associated with rising interest rates, but they won’t fall in price as much either.

The point is that bond duration is a useful risk metric.  When a fund has a higher duration it tells us that its price will fall more dramatically when interest rates rise as compared to a lower duration fund, but it should benefit more from higher current income tied to higher yields.  The key, however, is your investment time-horizon.  As an investor, you’ll be able to benefit from the higher current income of a longer duration bond fund only if your time-horizon exceeds the fund’s duration.  When it does, higher income over the long-term should offset near-term price declines.

This dynamic – of higher income offsetting falling bond prices – is related to the nature of bonds and is nicely illustrated by the Bloomberg Barclays U.S. Aggregate Bond Index.  According to Charles Schwab, since 1976 over 90% of this index’s total return has come from income payments rather than price changes.

While most investors should fair well with a bond fund that is aligned with their investment horizon, diversification is another important consideration.  As stocks have historically delivered the strongest long-term returns and have outpaced inflation since the early 1900’s, bond investments are best used when there is a specific income need.  When this is the case, having a mix of shorter and longer-duration bond funds can help an investor take advantage of a changing interest rate environment and mitigate sharp price swings.  In today’s environment, owning bond funds with varying durations – in proportion to one’s income needs, investment time horizons, and risk tolerance – an investor should be better able to take advantage of rising interest rates.  For example, let’s take a client with 20% of his bond holdings in a short duration fund, 20% in an intermediate duration bond fund, and 60% in a long duration bond fund.  If interest rates were to rise sharply, the lower duration fund would see a small if negligible decline in value. In some cases, it may make sense for the investor to sell some of those shorter duration securities and use the proceeds to add to their long duration bond fund, which would now have a higher current yield.

In addition to duration and price sensitivity, Parsec’s Research Committee considers many other factors when constructing a client’s fixed income portfolio.  We also look at where we are in the credit cycle, the underlying quality of each bond asset category, valuation levels, and inflation sensitivity, among others.  Although thorough and well thought out research is critical to meeting your financial goals, staying invested for the long-term is even more important.  When appropriate, doing so with a fixed income portfolio can help you better weather significant price swings and ultimately benefit from current income.

Thank you,

The Parsec Team

Share this:

Why Don’t We Trade in Round Lots (or at least round off the shares)?

Over the last two years, you may have noticed that some of your individual stock holdings have gone from neatly-rounded share amounts, to odd-numbered share amounts. Why did this happen?

First, a little history.

In the days before computers, market specialists traded shares on paper in a physical stock exchange (think Trading Places). In order to make the math easier, they traded in what are called “round lots” or shares in multiples of 100. If you wanted to trade an odd lot back then, you would incur an additional cost. Once computers took over the trading landscape, odd-lot trading was no longer difficult. It’s just as easy for a computer to match round lots as it is for them to match odd lots, so there’s no extra fee associated with trading an odd lot. In addition, the advent of algorithmic trading has contributed to the increase in odd-lot trading.

Since there is no longer any impediment to trading odd lots, this is how we’ve purchased shares of stocks and ETFs for our clients for many years. Up until a couple of years ago, however, we still rounded off the share amounts to the closest 5 or 10 shares, primarily because those of us who work with numbers tend to appreciate evenly-rounded shares, neatly made beds, and spice cabinets where all the labels are lined up (and in my house, parsley/sage/rosemary/thyme must always be arranged thusly).

Alas, two years ago, our hospital corners came untucked by none other than a software program called iRebal. A fantastic program in so many ways, one of its features is, that it likes to calculate trades in dollars. This makes a lot of sense for the type of rebalancing that we do, which is always dollar-based. With our previous software, Portfolio Managers took an extra step to manually round-off the stock shares to the closest 5 or 10 before sending the trades to the blotter to be executed. iRebal saves the rounding to the last minute, so that it happens AFTER the trades reach the blotter. Prior to execution, the trader refreshes the stock prices and the share amount is calculated at that time. In this way, we are protected from buying or selling too much based on stale pricing. In addition, we found that having the software round the shares to the nearest 1 (rather than 5) resulted in a more accurate portfolio rebalance. And yes, we did have a lengthy discussion about switching to a nearest-one rounding convention, but decided that 1) since odd-lot trading does not result in a price disadvantage, and 2) it helps us achieve our stated rebalancing goals on behalf of our clients, it’s worth wrinkling the sheets a little bit.

Sarah DerGarabedian, CFA
Director of Portfolio Management

Sarah DerGarabedian

Share this:

Why Trying to Time the Market is a Losing Game

The U.S. stock market has returned 282% since bottoming in March 2009, following the Financial Crisis.  Since that time, the S&P 500 Index has delivered positive returns in seven out of the last eight years and appears poised to produce another gain in 2017.  While it’s true that valuation levels are above long-term historical averages, in this email we’ll explore why trying to time the market is a losing game.

As a client you may be concerned that higher stock valuation levels coupled with a long-running bull market could mean an imminent pullback.  If so, you’re not alone.  Many investors have noted that it’s been a while since we’ve had a major stock market correction (defined as a drop of 10% or more).  This makes sense given that historically, the stock market has averaged three pullbacks of about 5% per year, with one of those corrections typically turning into a 10% or greater decline.  While it has been twenty-two months since our last market correction, we’ve seen longer.  Since 1990, we’ve experienced three periods lasting longer than twenty-two months over which markets did not experience a 10% or greater pullback.  So although we’re not in uncharted territory, the historical record suggests we could be closer to a market decline than not.

Given the above facts, clients often ask why we don’t sell stocks and raise cash in order to avoid the next market correction.  It’s a fair question, but when examined more closely we find that it’s a very difficult strategy to implement successfully.

Research has shown that trying to time the market is a losing game.  One reason is that an investor has to accurately predict both when to get out of the market and when to get back in.  While it’s difficult enough to time an exit right, the odds of then correctly calling a market bottom are even lower.  Part of this relates to the nature of market declines.  Looking back to 1945, the average stock market correction has lasted just fourteen weeks.  This suggests that investors who correctly sell their stocks to cash may be sitting on the sidelines when equities surge higher, often without warning.  While moving into cash may avoid some near-term losses, it could come at the higher cost of not participating in significant market upside.

Another reason to avoid market timing relates to the nature of market returns.  History shows that since 1926, U.S. large cap stocks have delivered positive returns slightly more than two thirds of the time.  As a result, you’re much more likely to realize higher long-term gains by remaining fully invested in stocks and weathering some of the market’s admittedly unpleasant downturns.

At Parsec, instead of market timing, we recommend investors stay invested throughout market cycles.  While this can be difficult at times, investing in a well-diversified portfolio has been shown to help mitigate market volatility and provide a slightly smoother ride during market downturns.  This is because portfolios that incorporate a thoughtful mix of asset classes with different correlations can provide the same level of return for a lower level of risk than a concentrated or undiversified portfolio.  It also ensures that investors participate in market gains, which often materialize unexpectedly.

In addition to constructing well-diversified portfolios, we believe in setting and maintaining an appropriate asset allocation based on your financial objectives and risk tolerance.  We then rebalance your portfolio to its target weights on a regular basis.  This increases the odds that you sell high and buy low.

Share this:

(Tax loss) Harvest Season is Almost Here!

The kids are back in school, the leaves are changing colors, and pumpkin spice lattes – the age-old harbingers of harvest season – are everywhere. At Parsec, we are preparing for the harvest…of tax losses.

Every year, beginning in late October/early November, Parsec’s portfolio managers will scour clients’ taxable accounts for meaningful losses, which we can use to offset realized gains created from trading throughout the year. These tax-efficient trading strategies provide value to clients by minimizing their tax burden while keeping the portfolio aligned with their financial planning goals.

You might see trades from one security into another one that is similar, but not exactly the same – we do this so that you can recognize a loss while maintaining exposure to the same industry or sector, yet avoid incurring a wash sale. According to IRS publication 550, “a wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale, you buy substantially identical stock or securities,” either in the same account or in another household account, including IRAs and Roth IRAs. Stocks of different companies in the same industry are not considered “substantially identical,” nor are ETFs that track the same sector but are managed by different companies (like a Vanguard Emerging Markets ETF vs. an iShares Emerging Markets ETF).

Sometimes it makes sense to place a loss-harvesting trade and leave the proceeds in cash for 31 days, then repurchase the same security. We may do this for clients who have cash needs during the holiday season, with the intention of placing rebalancing trades in January when there is no more need for liquidity. When liquidity is not an issue, however, we prefer to keep the funds fully invested in another high-quality name. We may later choose to reverse the trade, once the wash sale period has expired, or we may leave the trade in place if we think it is appropriate and suits the clients’ needs.

Sarah DerGarabedian, CFA
Director of Portfolio Management

 

Share this:

Value Stocks May be Poised to Outperform

Since Parsec’s founding in 1980, we’ve touted the benefits of long-only equity investing.  This includes owning individual stocks, mutual funds, and exchange traded funds (ETFs).  We’ve also maintained the same investment style over the last thirty-seven years.  Regarding funds, Parsec’s investment policy committee (IPC) focuses on low fees, higher-quality holdings, and managers with long track records of outperformance.  When researching individual stocks, we take a value approach, favoring higher-quality companies that trade at a discount to history or peers.

While history shows that value stocks have outperformed growth stocks over most market periods, in recent years growth stocks have delivered higher returns.  In this email we’ll discuss what we mean by value versus growth investing and why we believe value stocks are poised to outperform going forward.

Different stock investors define “value investing” differently.  However, most agree on a few basic principles.  In general, value investors prefer stocks that trade at discounts to their intrinsic values.  Often this happens when a stock’s valuation falls below its long-term historical average or that of its peers.  Another tenet of value investing is margin of safety.  This means selecting stocks that can deliver healthy total returns even if current growth assumptions fall short of expectations.  While we consider ourselves value investors, we will add select growth stocks to the Parsec buy list when expectations look reasonable and a company has a competitive advantage.  In other words, when we think a stock has a reasonable margin of safety.

In addition to a value-based stock selection approach, Parsec’s investment philosophy also has a quality bias.  This means we prefer companies with strong cash flows, consistent earnings growth, a long history of dividends, and above average returns on invested capital.  We also favor companies with strong balance sheets that can withstand different market environments and even gain market share during difficult economic periods.

Looking back over the market’s history, value stocks have outperformed growth stocks by an average of 4.4% annually from 1926 to 2016 (Bank of America/Merrill Lynch).  More recently from 1990 to 2015, value stocks outperformed growth stocks by just 0.43% annually.  The spread has since reversed and in the last ten years value stocks have lagged growth stocks by 3% annually through the second quarter of 2017*.

The shift in leadership from value to growth stocks coincided with the start and continuation of the Federal Reserve’s massive monetary accommodation programs known collectively as quantitative easing (QE I, II, and III).  Those programs put additional downward pressure on interest rates.  In the face of low or no yields and the slowest economic expansion after a deep recession in over 120 years, investors demonstrated a preference for growth stocks over value stocks.  They were willing to pay up for companies delivering higher growth in a world where growth had become scarce.  Throughout the last ten years value stocks have occasionally outperformed, but usually in tandem with a steepening Treasury yield curve and thus improving growth expectations.

Because asset prices and interest rates are inversely correlated, very low interest rates over the last decade have led to above-average asset valuation levels.  This has been even more pronounced among growth stocks as investors have been willing to pay a premium to own them in a slow growth environment.  As a result, typically higher-priced growth stocks are even more expensive today.

Sticking to our value- and quality-biased investment approach has admittedly been a headwind in recent years.  However, we believe higher-quality stocks trading at a discount are poised to outperform.  Growth stocks currently trading at premium valuation levels will have further to fall in the event of a market downturn.  As well, low interest rates have prompted corporations to take out record debt levels.  As rates begin to rise, higher-quality companies or those with strong balance sheets and robust cash flows will be better able to service their debt levels, even during an economic downturn.  While maintaining our investment approach through the current environment has been challenging, we feel confident that investing in higher-quality companies trading at discounted valuations will reward clients over the long-term.

*References the Russell 3000 Growth Index and the Russell 3000 Value Index

The Parsec Team

Share this:

Gen Y, Say Yes to Stocks!

It started with anecdotal evidence: a conversation with a co-worker about a group of professionals he spoke to about their 401k. The wiser (by which I mean older) folks were asking about the outlook for the economy and how they could maximize their 401k contributions. But the young man in the group, who was in his early 30s, expressed complete contempt for the stock market.  All of his money, he said, was in cash. Then a client of mine who is nearing retirement called me just to tell me about a dinner he went to where the topic of investing came up.  He was shocked at how vehement the young people at the table were about not investing in stocks due to their risk.

Since then I’ve read about a growing body of evidence coming from surveys and other research that suggests that the younger generations are too conservative in their investments. Gen Y is saving but not investing aggressively enough. The problem is that they distrust financial institutions (we don’t count) and believe another financial meltdown is all but imminent.

Gen Y, we don’t blame you. You were in your teens on Sept. 11, 2001, which had to have rocked whatever concept of stability you had. By the time you were old enough to know what the stock market was, the technology-driven crash of 2001-2002 was causing strife in budding 401k plans. And just when you were starting to dream about home ownership the housing market was spiraling out of control in 2008-2010. Many of you watched your parents go through extreme financial duress during this time period, something you were well old enough to understand.

It’s no wonder that Generation Y is too conservative. Your generation doesn’t have the benefit of personally experiencing the roaring 80s and 90s to boost your confidence about the markets. You don’t know who Crockett and Tubbs are. Looking at historical stock returns on paper just isn’t the same as living through it. And it’s hard to understand why men ever wore over-sized shoulder pads, but they did. Even the last five (amazing) years of positive stock markets seems like mere payback for the horror of 2008-2009. Despite this, we have to remember that stocks have historically provided the highest long-term return. No matter what your steadfast beliefs are about the future of the economy, it probably carries no more predictive capacity than the next differing opinion. That’s why we look to history as a guide, rather than trying to guess the future.

When you look at stock volatility over long time frames, it isn’t nearly as risky as the day-to-day movement would have you believe. In the last 87 years large company stocks’ annual returns ranged from -43% in the worst year to +54% in the best. That’s quite a spread! But those same stocks in any given 20 year period (starting on any given day in any year) averaged returns in a range of +3% in the worst 20-year period to nearly +18% in the best 20-year period. That includes the Great Depression and the market crashes of this century. That’s a lot easier to swallow. You have a long time before liquidating your accounts for retirement – probably more than 30 years, so you should be taking a longer term view.

And let’s not forget about inflation. That cash that’s in your 401k is doing less than nothing for you. Long run inflation is around 3%. If you are getting a 0% return on your cash, that is actually -3% in real dollars, guaranteed.

Saving money isn’t good enough. Millennials need to invest with a little more oomph. Yes, diligently putting away $500 a month for 30 years is hard work and no one wants to see their money shrink. But consider this: if you get a modest 4% average return on those savings, you will have $347,000 in retirement; if you double that return to 8% an amazing thing happens: $745,000. Taking risk means a lot of ups and downs along the way, but potentially twice the money in the end. If you can go cliff-jumping with your friends, you can buy stocks, right? (No? Was that just my friends?)

There is no reward without risk, to be sure. Any investment plan should be done with the full comprehension of the volatility, range of outcomes and potential for return. There certainly is risk in losing money in the stock market over short and intermediate time periods. However, those losses only become permanent if you sell out during periods of decline. It seems all but certain that an all-cash/fixed income portfolio is doomed to growth too slow to possibly reach any long-term financial goals.

 

Harli L. Palme, CFA, CFP®

A Gen-exer who believes all of the above applies to her generation too, except the part about over-sized shoulder pads.

Share this: