Thousands of books have been written on investing and investment philosophies, some reputable, some unproven, some similar to gambling. The Bible provides us insight into many time-tested investment strategies and attitudes. We will discuss four of them.
Dollar Cost Averaging/Systematic Contributions
Proverbs 21:5 says, “The plans of the diligent lead surely to abundance, but everyone who is hasty comes only to poverty.” The first part of the verse, “The plans of the diligent lead surely to abundance” describes the concept of dollar cost averaging and systematically investing. If you are saving in a company sponsored retirement plan, like a 401(k), 403(b), SIMPLE IRA, or something similar, you are practicing this concept. If you are saving in an IRA, Roth IRA, or anything else in which you are putting money away consistently, then you are practicing dollar cost averaging. It means you are putting money away each paycheck, monthly, quarterly, or annually, and buying into an investment regardless of what that investment is doing at the time. Sometimes you are buying the investment at a lower price, sometimes at a higher price. But usually when you figure out your average price over time, it’s going to be lower than if you just made a large one-time deposit. That’s dollar cost averaging: making small contributions gradually over a long period of time, methodically, systematically, automatically. This is what Proverbs 21:5 means by “the diligent lead surely to abundance”. God’s Word tells us that hard work, saving consistently and faithfully is rewarded. The second part of Proverbs 21:5 concerns your expectations.
Stock Market Expectations
The second part of Proverbs 21:5 says, “everyone who is hasty comes only to poverty.” Hastiness, acting with urgency, being hurried, not being patient, and making uninformed decisions because of it, can affect many areas of our investment savings, and usually not in a positive way.
We know markets can fluctuate up or down, for various reasons. All too often I see unrealistic expectations of stock market performance. This leads to the average investor to act in haste. Some believe they should expect 10-12% annual rates of return, and this is even fueled by a handful of tv and radio ‘financial gurus’. This misinformation does a disservice to those who now have expectations that aren’t attainable for several reasons. First, this assumes you are an aggressive investor, taking on full stock market exposure of both domestic and international stocks. However, upon completion of risk tolerance analysis, few fall into the 100% stock, aggressive category. Most people tend to fall into a more moderate/balanced allocation, which means some of their money will be allocated to bonds. Bonds are usually more stable and usually have lower performance expectations than stocks. So right away, expecting 10-12% performance is not realistic.
Additionally, when you look at past stock market performance, there’s a tendency to take a historical average and make an assumption that is what should be expected in the future. Here’s the problem with taking historical averages: math is not money. For example, you invest $100 and at the end of the year, it drops to $50. You will say you had a -50% rate of return. What does your rate of return need to be the next year to get back to $100 where you started? You must see a 100% increase to be back to what you put into it. You would think if you were down 50% in year 1, then up 50% in year 2, which is an average of 0% rate of return that you’d be back at $100, but you’d actually have $75 at the end of year 2 in this scenario. Negative performance numbers distort averages, and this leads to a disparity between performance averages and actual money. Crestmont Research (https://www.crestmontresearch.com/blog/document/distorted-averages/) has done analysis of simple performance averages vs. actual compounded averages for the Dow Jones Industrial Average from 1900 to 2020. The simple performance average for the popular stock market index comes out to 7.4% annually. However, when you apply these averages to actual money, the compounded average, you end up with is just 5.2% per year. It is important to have proper expectations, in order to avoid hasty decisions. Every stock index will have different numbers, but the same concept holds true.
Saving vs. Performance
Uninformed market expectations can also lead to the dangerous assumption that a portfolio’s rate of return should be the main catalyst of the account value’s growth over time. I’ve seen many who decide to save, but at such small amounts, it’s almost insignificant. And then they expect to see market performance turn that small amount into something to be able to retire on. To put it simply, saving for the future is not about better investment returns, it’s how much you’re actually saving. Galatians 6:7 reminds us that we reap what we sow. If we put little into our savings, we can expect just as little when it’s needed.
Diversification
A verse already used in a past blog on Protecting also applies to the investment concept of diversification. Ecclesiastes 11:2 says, “Give a portion to seven, or even to eight, for you know not what disaster may happen on earth.” When it comes to investing, diversification means allocating your money across different types of investment styles with the goal of reducing risk and volatility. Often, we look at types of investments that are not fully correlated to each other to gain diversification. If two types of investments are correlated, then they typically move in a similar direction. If two investments are not correlated, then they typically move differently. Stocks are not correlated with bonds, so a basic diversification method is to choose an investment allocation based on your risk among a mix of stocks and bonds. Additionally, within bonds and within stocks, you can diversify further, which serves to not only spread out your risk, but also provides the opportunity to realize growth of a certain asset class that may be having a better year compared to others. Basic examples are international stocks and domestic stocks, large cap stocks and mid & small cap stocks. An online search for diversification charts will demonstrate how investment styles that outperform one year can be one of the worst performers the next year and vice versa. If you look at your investments and see that they’re all doing well at the same time, they’re highly correlated. As nice as this is, you are most likely not properly diversified. The reverse of this scenario when your investments are correlated, would be that you should then expect them all to go down together as well. The goal of diversification is to reduce risk.
As always, let me know what you think! Drop me a line at Christopher.Hull@CeteraInvestors.com or call me at 716-707-1818.
Next Time: Investment Decision Making
Investments in securities do not offer a fix rate of return. Principal, yield and/or share price will fluctuate with changes in market conditions and, when sold or redeemed, you may receive more or less than originally invested. No system or financial planning strategy can guarantee future results.
The views stated in this letter are not necessarily the opinion of Cetera Investors and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.