Note from Our CIO: Nothing Out of the Ordinary

I had a call with a potential client the other day. She explained that she was ready to leave her current advisor. We seemed like a good fit. Then she mentioned in passing that her advisor encouraged her not to sell during the 2008 financial crisis. So she stuck with her investments.

I told her this advice was probably the best she has—or ever will—receive, and that I could only hope to live up to her current advisor. It actually turns out that the advisor does not do any financial planning, and she now feels lost without a plan, which I told her I could help her with.

As investors, every year we’re faced with one apocalypse du jour meant to tempt us into giving in to our emotions so we can bail out of our investments. Emotions are the enemy of the investor. In fact, as the chart below shows, in the 35 calendar years since 1980 there has been at least one period of time each year when the stock market (defined here as the index of the largest 500 U.S. companies) declined by at least 3% (1995) and as much as 49% (2008).

The average of these intra-year declines, which no doubt were filled with great uncertainty for investors when they happened, was 14%.

Through September 30, 2015, the high for the index was on May 21 (2,131) and the low was on September 28 (1,882). This is a 12% decline. In other words, we are three quarters of the way through 2015, and this year is shaping up to be pretty average.

And yet as the chart shows, 27 of the past 35 calendar years have enjoyed positive returns despite the average 14% decline that happened during some of those years! As of September 30, 2015, the S&P 500 is down about 7% for the year overall. But the more important point is this: At the beginning of 1980, the S&P 500 index was 106. No, I did not leave out a digit. As of September 30, 2015, it closed at 1,920.

This means that if you had invested in the 500 largest U.S. companies at the beginning of 1980, the value of your money would be multiplied more than 18 times (1,920 divided by 106) today. This represents an 8.4% average annual return over 35.75 years. But don’t exhale yet, because along the way those companies paid out significant portions of their profits, known as dividends, which makes the total annual return 11.4%.

That means that your money would have multiplied nearly 50 times!

OK, breathe.

Here’s what this all means: $10,000 invested in the largest 500 U.S. companies at the beginning of 1980 would be worth about $500,000 today. This is despite that average annual decline of 14%.

It’s easy to take the world around us for granted and perceive that wealth creation over the past 35 years is fictional. But in moments of clarity, one can only be dumbstruck by its intricacy and brilliance.

Consider all that goes into a simple pencil (I credit this to “I, Pencil” by Leonard Read, which you can watch as a five-minute movie on YouTube). It represents the spontaneous organization of millions of skilled people responding to necessity and desire.

There are the loggers in the Pacific Northwest, the power saw and its engineering, the communication and transportation networks that deliver the wood to the processing plant. Then there is the graphite that is mined in China and the metal band shipped from all over the world.

Millions of people voluntarily exchange labor, skill, material, services and capital, as if led by an invisible hand. This is the modern world: miraculous and intricate. It gets better every day, and there is no limit to the wealth we can create together … so long as we are free to interact with each other.

This is why the advisors at Abacus encouraged our clients to take a deep breath during the 12% market drop this year. This is why we counseled our clients in 2008 that is was human to feel fearful but unwise to act on that fear. This is why, as an investment counselor, I can only hope to live up to the example set by my new client’s former advisor.

Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance. The S&P 500 was chosen as it is generally well recognized as an indicator or representation of the stock market in general. You cannot typically invest in an index and returns do not reflect fees or expenses.