In this section we take a look at the returns that would be captured by a hypothetical investor using various investment plans. We start with a table showing the economic recessions (business cycles measured from peak to trough) we’ve had over the last 40 years.
Business Cycles – 1969 to Present
EPISODE START END DURATION
1969 Dec 1969 Nov 1970 11 months
1973 Nov 1973 Mar 1975 16 months
1980 Jan 1980 Jul 1980 6 months
1981 Jul 1981 Nov 1982 16 months
1990 Jul 1990 Mar 1991 8 months
2001 Mar 2001 Nov 2001 8 months
2007 Dec 2007 Aug 2009 20 months
Why are we showing you a list of past recessions? Because when it comes to investing, recessions wreak havoc on the stock market. We pay close attention to the business cycle at ZenInvestor, and when there is enough evidence to show us a high probability that the cycle is peaking (recession is just around the corner), we tell our subscribers to cut back their allocation to stocks. Our most aggressive members sell all their stocks, and put 100% of their money in cash or treasury bills. Successfully avoiding the carnage caused by recessions will improve your returns by 4% per year, on average.
The stock market can also go down when there is no recession. We call these non-recession bear markets, and they’re especially dangerous for the health of your portfolio. The reason they’re so dangerous and costly is because they scare investors into selling their stocks prematurely. In a typical non-recession bear market, investors wait until the market is down so much that they just can’t take the pain any longer. They sell their stocks just before this downturn is over. When the market recovers, they don’t want to believe that the decline is over, so they wait. By the time they realize that the market is going to be o.k., they have to buy back their stocks at much higher prices. This is a “sell low, buy high” strategy – exactly the opposite of what investors should be doing.
We use a set of proprietary indicators that allow us to distinguish between a real bear market and a fake one. A real bear market is one that’s accompanied by a business cycle peak and the subsequent recession. We warn our subscribers when the probability is high that a real bear market is coming. A fake bear market is one that is not accompanied by a recession. When the market is going through one of these fake bear markets, we encourage our members to stay invested, don’t panic, and ride out the storm. Our work shows that fake bears are less severe, and don’t last as long, as real bears.
So the question is, how much better will an investor do by staying invested during fake bear markets, and getting out of stocks during real bear markets? Take a look at this table which shows the impact on returns from successfully avoiding recessions while staying invested at all other times.
Average Annual Returns from 1983 – 2009 Average Investor 3.80%
Zen Investor – conservative portfolio 8.15%
Zen Investor – moderate portfolio 10.22%
Zen Investor – aggressive portfolio 13.57%
The Market (S&P 500 Index) 9.62%
The average investor makes 3.8% per year, on average. The main reason for this poor result is that the average investor can’t tell the difference between a bear market that’s caused by a recession, and one that’s not. When the non-recession bear market hits, this investor waits until the market is down significantly, and then sells. After the market recovers, this investor again waits too long, and ends up buying back his stocks at much higher prices. The 3.8% figure used in this table is from Dalbar, Inc. and The Investment Company Institute.
The Zen Investor subscriber who uses our most conservative portfolio (less invested in stocks, and more in bonds and cash) has done more than twice as well as the average investor. The reason for this is that the conservative portfolio stays invested in stocks during non-recession bear markets, and successfully avoids the stock market during the actual recessions.
The subscriber with the moderate portfolio does better than the conservative portfolio because he has more exposure to stocks, and less to bonds and cash.
The aggressive subscriber has the most exposure to stocks, in some cases 100% exposure. When the business cycle peaks, this investor sells all of his stocks and goes 100% to cash or treasury bills. Because of this, the aggressive investor maximizes his possible returns and beats the S&P 500 Index by almost 4% per year over the long term. We don’t recommend the aggressive portfolio to all of our subscribers, because it requires significantly more time to monitor and manage, and because it requires nerves of steel to stay invested in stocks when the market is down sharply. Investors who don’t have the stomach for volatility should stick with the moderate and conservative versions of our model portfolios.
To learn more about how our models work, click here.