Be The Tortoise

Take a look at the two hypothetical portfolios below – the tortoise portfolio and the hare portfolio. If you somehow knew in advance that they’d perform as shown, which would you choose?

 
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Most would choose the hare, believing it generates a higher rate of return. And that’s just how many investors and other advisors choose their investments – by focusing on returns and ignoring risk. Such a strategy usually fails – as it does in this example – as the tortoise makes more money than the hare. At the end of five years, a $10,000 investment in the tortoise portfolio grows to $16,105.10 vs. the hare’s $15,785.19.

Not only does the tortoise make more money, it does so with far less risk. Statistically speaking, the volatility of each portfolio suggests a 95% probability that the tortoise in any one year will earn 10% while the hare could LOSE 25%!

Here’s a real-life example showing how the 9% average annual return of a lower volatility market index (U.S. Long-Term Government Bond Total Return Index1) beat the 9% average annual return of a higher volatility market index (Goldman Sachs Commodity Index2) from 1994- 2008 …by over 80%! Please note these examples do not in any way constitute an investment recommendation – as I would never recommend a non-diversified portfolio made up of any one index or asset class – and past performance is no guarantee of future results.

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“The essence of investment management is the management of RISKS, not the management of RETURNS.  Well-managed portfolios start with this precept.”

Benjamin Graham
Legendary Investor

 

Market Timing

What about market timing, a strategy where one moves in and out of investments based on “gut feelings” or perceived market conditions? Scholars have estimated that from 1926-1993, any investor had the following chance of timing the market correctly all of the time:

0.00000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000022883557%.

 

Market timing is not only a losing game odds-wise, it can prove disastrous to long-term investors’ returns since the bulk of the markets’ gains have historically come in relatively few days. In the 1980’s, for example, fully 40% of the S&P 500’s positive returns came during ten days – about 0.5% of the time.

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Data Sources: “Stock Market Extremes and Portfolio Performance,” Nejat Seyhun, 1994. “A Nonparametric Test of Market Timing,”Wei Jang, 8/01. “Sequential Optimal Portfolio Performance: Market and Volatility Timing,” Michael Johannes, Nicholas Polson, Jon Stroud, 2/02.  Data Source: "The (Mis)Behavior of Markets," Benoit Mandelbrot, Richard L. Hudson, 2004.

What Were The Odds?

 

S&P 500 dropping 14.5% the week of 2/24/2020
1 in 14,000

Dow dropping 6.8% on 8/31/98
1 in 20 million

Bloomberg Aggregate U.S. Bond Index crash 2022
1 in 50 million

India’s Sensex index dropping 11% on 5/17/2004
1 in 500 million

Italy’s FTSE MIB index dropping 12.5% on 6/24/2016
1 in 3.1 billion

Dow dropping 7.7% on 10/27/1997
1 in 50 billion

Dow dropping 3.5% on 8/4/1998
Dow dropping 4.4% on 8/27/1998
Dow dropping 6.8% on 8/31/1998
A combined 1 in 500 billion

Spain’s IBEX 35 index dropping 12.4% on 6/24/2016
1 in 6.4 trillion

British Pound dropping 8.1% vs. the US Dollar on 6/24/2016
1 in 10 to the 48th power

Dow dropping 29.2% on 10/19/1987
Less than 1 in 10 to the 50th power

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“Real investors know better than the economists.  They instinctively realize that the market is very, very risky, riskier than the standard models say.”

Benoit Mandelbrot
Mathematician

According to mathematician Benoit Mandelbrot, “(O)dds so small they have no meaning. It is a number outside the scale of nature. You could span the powers of ten from the smallest subatomic particle to the breadth of the measurable universe – and still never meet such a number.”

Data Sources:

"The (Mis)Behavior of Markets”, Benoit Mandelbrot, Richard L. Hudson, 2004.

“Things You Need to Know About Six Sigma Events in Stock Markets”, Marketcalls.in, 8/2/2015

“How Many Sigmas Was the Flash Correction Plunge?”, Kevin Cook, Zacks.com, 3/4/2020

“By One Measure, 2022 Bond Crash Is Worse Than Stocks During the Great Depression”, Allan Roth and Wealth Logic, Barron’s.com, 10/31/2022

“High Sigma Events – They’re Not All Black Swans”, Vance Harwood, SixFigureInvesting.com, 7/4/2023