This morning I read about a nine-year-old boy who is trading stocks in his Robinhood account, which gave me pause. I imagine he has had success because, well, who hasn’t? What a wonderfully positive market we have all experienced over the last decade: little downside, meme stocks raising, SPACs, IPOs, and everyone has the Midas touch.
We have all been lulled into thinking this market is the norm. The Great Recession is a fading memory and the minor ups and downs and not so minor correction in March of 2020 has not stemmed the flow of money into equities.
When children are jumping on the stock trading bandwagon, is this the signal that we are at the top? Stock markets tend to revert to the mean and if that continues to be accurate, we have a reckoning coming.
This led me to start thinking about what advice I would give to the nine-year-old trader? How can I prepare him for long-term market realities? What could I say that would motivate him to keep investing?
The advice that rises to the top of the list is simply stay invested. The impact of missing even a few of the best days can impede the performance of any portfolio. The following research produced by Dimensional Fund Advisors shows the hypothetical growth of $1000 invested in the S&P 500 since 1990. Missing the best performing day in the market reduces the gain by over $2000! Missing the five best days reduces the returns by 36%.
Another key to investing success is to think long-term. Investing is a marathon not a sprint. Markets rise over time and the patient investor wins in the long run. This chart shows, at a glance, that bull markets last longer and with more intensity than bear markets.
The value of a company’s stock lies in that company’s ability to grow and be profitable over time. Companies work toward that end year to year. So, the outcome evidenced in the chart is less surprising once you understand that companies find a way to make money for their shareholders and executives.
Although often mentioned, another key to success is diversification. Every investor needs to diversify their portfolios to produce the gains available in any given year. Not everything goes down or up at the same time. The patchwork quilt in the next chart shows the changes in the top performing developed markets every year. Trying to predict which will win out is not possible to do consistently over time.
Diversification applies to numerous factors including the following:
- Company size: small cap, mid cap and large cap
- Industry: finance, consumables, utilities, technology, etc.
- Location: US based and international
- Economy: Developed, emerging, frontier
- Asset Class: Equities, bonds, real estate, commodities
- Account type: Tax-deferred such as IRAs and 401Ks, taxable, Roth IRAs, trusts
The last key, which is probably the hardest concept to teach a nine-year-old, is to maintain discipline. At nine, thoughts of discipline turn to punishments for bad behavior. Like a child, however, adults can also be overwhelmed by emotions as markets fluctuate which results in making poor investment decisions.
Individual investors consistently underperform. Dalbar Inc.’s Quantitative Analysis of Investor Behavior report which has been done annually since 1984, finds that investors react emotionally to market swings impeding their ability to achieve long-term financial success. They fall for marketing timing or performance chasing and lack the discipline to maintain a consistent investment strategy overtime.
Emotions surrounding investing tend to follow the following diagram. In a rising market we feel optimistic and even elated which is when most investors get into the market only to feel nervous and even fearful when markets decline at which point investors sell thereby locking in losses. This leads to the classic buy high, sell low cycle of many novice investors.
In a way, the advice for a nine-year-old is also a valuable reminder to all of us. We have had a remarkably positive market for over a decade. When the inevitable bear market returns, will you have the discipline to survive?