Investment Cliches: Are They Helpful or Not?
What’s the main reason any of us invest in stocks? Reward, right? It’s because:
The market, on average, will return 8% per year.
We’ve heard that so often that most of us just take it for granted. Sure, we’ll add caveats like “over the long term” or “around 8%,” but it’s a statement that holds true for most sensible investors. Why? Because history says so. Even with the huge dip stocks have just gone through, the S&P has returned right around 7% per year since 1950. On average, of course.
It’s shocking to me that so many of us buy into that 8% number. How do you reconcile that cliché with this one:
Past performance is not an indicator of future returns.
How many times have you heard that one? It’s in practically every single mutual-fund prospectus as a legal clause that protects the people selling it to you. Here’s basically what it’s saying:
Here, we’re going to show you how this fund has done in the past because we know you want to see it. You just can’t resist it—that’s just the way you wacky investors are. And we’re so sure that you’re going to give past returns so much weight that we’re going to throw in this line that says that past returns have absolutely nothing to do with what will happen in the future. Why? Well, because it’s true. But also because we want to cover our asses.
I know what the next step should be: I should tell myself that I’m investing in stocks because I can handle the added risk in exchange for the added reward. But I’m still having trouble reconciling these two thoughts in my head.
With that, I leave you with some F. Scott Fitzgerald:
The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time, and still retain the ability to function.
I’m working on it…
May 15th, 2009 at 9:44 pm
The 8 percent gain a year seems more than a little misleading because the market is rarely that steady. There will be years( like the 90s) where the market will skyrocket and then there will be times like right now.
May 15th, 2009 at 9:50 pm
That’s the thing David, it’s not misleading because of the “on average” disclaimer. But that’s for a later post on my definition of “long term.” Stay tuned.
May 21st, 2009 at 8:09 pm
For the ’8% return’ idea in particular, I think it’s useful to have an idea of how much return to expect from our investments. Admittedly, we tend to put too much emphasis on the 8% return (or 10%, or 7% more than inflation, or whatever figure you hear), as if the stock market was just a high-yielding bank account rather than a highly variable investment. But if you are decades from retirement and trying to figure out how much to invest to meet your goals, it’s good to have some idea of the amount of return to expect.