When we started Young Research’s Retirement Compounders (RCs) in 2003, the goal was to look for a compelling competitive advantage to make the RCs a big winner, especially during bad times. Our strategy was to accept underperformance during speculative market runs, regardless of the duration, with the expected tradeoff of better performance during bad markets. Patience is always required with such a strategy.
The idea was never to beat the market over time or on a consistent basis. Rather, we fully expected the low risk RCs (both price risk and business risk) to trail the major market averages. We know this is blasphemy in the investment management business where the raison d’etre of many (especially mutual fund managers) is to outperform the market. But few in the industry acknowledge the ugly reality that the average equity investor vastly underperforms the market. This is true even for investors who own market beating mutual funds.
Work by Dalbar shows that over the last 20 years, the average equity investor has trailed the S&P 500 by an astonishing 4.32% per year. High volatility is to blame here. Investors tend to sell in a panic near the lows and add to their stock positions near a market top. Take 2011 for example, a year of heightened volatility in the stock market. In the first four months of 2011, the S&P 500 rose 8% only to drop 20% over the next five months. Then in the final three months of the 2011, the market gained 15%. The net result was a 2.1% gain for the S&P 500. How did the average equity investor do in 2011? He lost 5.7%.
By crafting lower risk portfolios, the goal of the RCs is to help investors avoid the emotionally charged investment decisions that often lead to abysmal long-term results.