5 Investing Myths Used by Financial Salespeople: Part 3 :: Wamhoff Financial & Accounting


5 Investing Myths Used by Financial Salespeople: Part 3

Investors Should Always Be Invested in the Stock Market

The financial crisis that occurred from late 2007 until the spring of 2009 rattled global financial markets. The U.S. stock market indexes were not spared during 2008 when panic level selling pressure persisted. The major U.S. stock market index returns in 2008 are shown below:
2008 Stock Market Returns - graphic 1
This chart or graph is hypothetical and for illustrative purposes only. It is not intended to show the performance or return of any particular investment. Past performance cannot guarantee comparable future results.

As can be seen, 2008 was a horrible year for the major U.S. stock market indexes. All of the stock-based indexes were down more than 30% as the United States slipped into the worst recession since the Great Depression.

Based on the table above, investors did not want to be fully invested in equities in 2008. However, one of the primary investment myths perpetuated by so-called financial advisors is the notion that investors should always be invested in stocks. The rationale employed by financial salespeople is to tell investors or prospective clients that there has never been a 10-year rolling period where stock market indexes were negative.

Robert Shiller, an American Nobel Laureate, who currently serves as a Sterling Professor of Economics at Yale University, presented data that the following chart from streettalklive.com is based upon:
Rolling 10 year rates of real returns - graphic 2
This chart or graph is hypothetical and for illustrative purposes only. It is not intended to show the performance or return of any particular investment. Past performance cannot guarantee comparable future results.

The chart shown above makes two facts very clear:

  1. There are various periods throughout history where stock market returns over 10 year rolling periods were negative or produced very low returns.
  2. Generally speaking, periods of low or negative returns immediately followed historical periods where stock market returns were very strong.

The chart above essentially refutes the financial sales jargon that there has never been a 10 year rolling period in history where U.S. stock market indexes were negative. (HINT: Look at the period from 1975 to 1985.) However, there is a far more important takeaway that is illustrated by the chart above that many financial advisors fail to explain to their clients.

The timing of an investment is far more important to long-term returns than what financial salespeople would like to acknowledge. For a basic example, when looking at the chart above, the best time to invest in stocks in the past 50 years would have been from 1975 – 1985 and then again in 2008 – 2010.

A long-term, equity-based investment in either of those two time frames would have likely produced stronger long-term returns than purchases when equity valuations were considerably higher. This chart underscores the importance that the timing of an investment, paired with overall stock market valuations are critical when gauging longer-term historical investment returns.

Speaking of valuations . . . the chart shown below compares Professor Shiller’s CAPE ratio to the actual S&P 500 10-year forward average returns:
High Valuation Leads to Lower Future Returns - graphic 3
This chart or graph is hypothetical and for illustrative purposes only. It is not intended to show the performance or return of any particular investment. Past performance cannot guarantee comparable future results.

According to Lance Roberts of STA Wealth Management, “from current levels history suggests that returns to investors over the next 10-years will likely be lower than higher.” While we are not as confident about future stock market returns as Mr. Roberts, we do believe that equity valuations matter when considering a long-term stock market investment or accepting an investment model that subjects itself to a certain threshold of stock market exposure.

Financial salespeople are paid to sell investments to clients to generate commissions. The last thing they want to talk about is valuations. In many cases, the same sales tactics will be used to convince potential clients to make an investment in stock based portfolios. Financial salespeople will use long-term average performance and the statement that there has never been a 10 year period where stock markets returns were negative as a sales strategy to elicit a purchase from an existing or new client.

The charts above have proven that there has been long periods of time in U.S. history where stocks have returned negative, or very low returns over an entire decade. Additionally, investors need to be asking their financial advisors how investments that they own performed during periods where stocks sold off or during periods of economic recession. The average annual return over ten years will help financial salespeople hide potential volatility in the return profile of an investment. Consequently, financial salespeople will try to avoid discussing a specific investment or portfolio’s overall risk with a client or prospective client at all costs.

Financial salespeople certainly do not want to discuss the maximum investment or portfolio drawdown during the last stock market decline or economic recession. For readers who want to perform this test on their current advisor, simply ask your financial professional to discuss with you how your portfolio would have performed during 2008. If they want to avoid this conversation or immediately switch topics, this should be a major red flag and a second opinion from a different financial professional should be sought out.

While we are not trying to advocate for market timing, we do believe that having an active asset allocation strategy makes investment sense. There are times in history where reducing overall portfolio risk, or conversely increasing portfolio risk has made logical sense. This has been particularly relevant when considering a client’s unique risk profile and equity valuations when adjusting a portfolio’s overall stock market risk.

If your current financial advisor is not focused on equity valuations when determining your asset allocation or does not make a few portfolio adjustments each year, then you may be working with a financial salesperson and not a financial advisor.

Professional financial advisors will be focused on the client’s risk tolerance, the portfolio allocation at the time the investment is made relative to stock market valuations, and will openly discuss the risk the portfolio has if the stock market performs poorly in the short-term.

Stock market investments do not increase in value every year, and financial professionals should regularly discuss with their clients the risks that their investments have to make sure they fit their clients’ unique risk tolerance. This also helps financial advisors manage client expectations so that when portfolio adjustments need to be made, the client understands the rationale behind them. This process also helps prevent clients from making emotional investment decisions in the future if stock market performance becomes extremely volatile.

Consequently, asking questions about stock market valuations, listening for commonly used sales jargon to convince investors to purchase stocks, and questioning investment performance during periods of recessions or poor financial market performance are great ways to determine what kind of financial professional you are working with. If your financial advisor fails this basic test, it may be time to get a second opinion. As always . . . Happy Investing!

Sources:
https://en.wikipedia.org/wiki/S%26P_500
https://en.wikipedia.org/wiki/Russell_2000_Index
http://1stock1.com/1stock1_139.htm
https://en.wikipedia.org/wiki/Nasdaq_Composite
https://en.wikipedia.org/wiki/Robert_J._Shiller
http://www.zerohedge.com/news/2015-06-02/5-investing-myths-debunked