3 Charts that Shape my Investment Philosophy

August 21, 2023

You could speak with 1,000 financial advisors and get 1,000 different opinions on how to invest, where to invest, when to invest, etc etc.  Everyone has different methodologies they believe in and, frankly, there's no one strategy or philosophy that is necessarily superior to the rest.  The markets are uncertain by nature and so it's not possible to say what strategies are "best" because nobody truly knows what's over the horizon. Things that have never happened before happen all the time!  Yet while the markets are uncertain and constantly changing, my underlying investment philosophy is rooted in a few core principles that do not change and they help me to stay focused on the things I believe to be important when the markets are under duress.  I want to share those core principles with you and 3 charts that will help you visualize them.

1.  Investing is NOT Gambling 

You hear people all the time describe the stock market as a casino.  Of course at a casino, the house usually wins and we usually lose.  The longer you stay at a gambling table, the higher the odds you're going to lose money.  This is why casinos spend so much money on flashy decor and entertainment and food & drink options.  Casinos do everything they can to get you to spend more time there because they know the longer you're in their building, the more likely they are to take your money. 

This is literally the exact opposite of long-term investing.  As an investor, the longer you stay in the game, the higher your likelihood of making money!  See, in the stock market, YOU get to be the house.  

Take a look at this chart which will show you the historical odds of generating a positive return in the S&P 500.  

On a day to day basis, investing IS gambling.  Your odds of generating a positive return on any 1 day are basically a coin toss. But the longer the timeframe we look at, the greater our odds.  Look at what happens if we zoom out to a 1-year period.  Our odds of a positive return jump to 77%.   Extend that to 5 years and our odds are now 93%.  Push it to 10 years and your odds have reached 97%.  The longer you stay at the table, the greater your odds. 

Investing is NOT like gambling.  It's the opposite.  Stay at the table.

2. Stock Market Declines are NORMAL

The stock market, much to our chagrin, does not go up in a straight line. The market goes down periodically by all sorts of varying amounts.  Nobody knows when a pullback is coming but we do know for certain that a pullback is coming.  The one undeniable fact of investing is this: There is always a pullback on the horizon.  And that uncertainty can be interpreted as risk and cause some to be nervous but I'd argue that these periodic pullbacks are really not much of a risk to our long-term success.  If we simply hold our noses, look the other way and wait....History shows us that we'll come out of every market decline just fine.  Where we get ourselves into trouble is when we make a bad decision while the market is in a temporary correction and turn the temporary decline into a permanent one by selling our assets while they're down.  When the market is going down our brains may tell us the market is going to keep going down and the only way to stop the pain is to sell.  But why do our brains tell us that when we've got decades of data and hundreds of examples that teach us that all price declines for the S&P 500 index have been temporary and we should simply stay invested?  Well it's because humans are emotional beings and in stressful situations we can allow our emotions to take the wheel.  The problem is that our emotions are very bad drivers of our investment vehicles.  We must come to terms with the fact that the markets go down sometimes, and that's OK.  Let me show you just how normal market pullbacks are.  

This chart shows us how many times per year the market drops by various amounts.  

Our investments will probably drop by 3% or more 7 times per year.

About 3-4 times a year we should expect to see our investments fall by 5%.

Once a year we should expect to see our investments fall by 10%.  

Every 18 months we should expect to see our investments drop by 15%. 

And once every 2-3 years we should expect to see our investments fall by 20% or more.  

Despite the fact that our investments drop by these amounts all the time, the S&P 500 has delivered average annual returns of about 10% throughout its history.  Due to compounding, this means on average the S&P 500 has doubled in value every 7-8 years.  Now during that 7 to 8 year period, on average the market went through probably 20 unique 5% drops, 8 different 10% drops and a couple of 20% or greater drops.  Even so, $10,000 invested at the beginning of an average 7-8 yr period would've grown to $20,000 by the end of it.  All you had to do was not let your emotions take over during one of the many pullbacks and convince you to sell.  

The more comfortable we become with the idea that the market will always be on the verge of a pullback and that is OK, the better investors we will become and the higher our likelihood of making money over the long term.  Corrections are normal.  

3.  Forward Returns are Higher when the Market is Lower

This one sort of piggybacks on the previous point.  Simply put, the market usually pays you handomsely for keeping your nerve and staying invested through a downturn.  Like I said, our emotions can try to take the wheel and steer us away from our investments during times of market stress, but the data shows us this is a costly mistake.  When the market drops more than 10% it sometimes feels like the world is ending and I'm sure everyone on your TV is telling you to bury your money in the backyard and prep for armageddon.  But this simply isn't the case.  In fact, there are very few times where the odds are more in our favor as investors than when the market is down big.  Forward returns following the big market declines are tremendous.

Take a look at this chart which shows us all of the corrections since 1980 as well as the market returns in the years following:

First thing you'll notice is that it's a LONG list.  Like I said....corrections are NORMAL.  They happen all the time.  The next thing I want you to see is the average returns in the years following these past corrections.  The average return 1 year later is 25%.  This is more than double the average 1yr return in all other times.  Additionally, the odds of a positive return for the following year jumps to 90% versus 77% for all other 1yr periods.  So if we know that forward returns following corrections are more than double all other periods and our odds of a positive return are well above normal, why on earth would we want to remove our dollars at that time?  Well, we wouldnt!  If anything we'd want to find more dollars to get allocated to the market during the correction to take advantage of what has usually come next.  

Look no further than what we're going through at this very moment.  Last year the market dropped 25% at one point.  It felt like the world was ending.  Every statement was painful to open.  The talking heads were promising more pain.  And then what happened?

The market rallied 30% over the next 9 months. 

You probably know people who panicked and sold last year during the bear market and in that moment they probably felt like they'd made a great decision.  They stopped the bleeding.  They ended the pain.  I bet they felt relief in that moment.  But how do you suppose they feel about the decision they made now, just 9 months later?  Probably pretty sick.  That's what can happen when our emotions take the wheel of our investment vehicle.  

This core principle is what is behind the famous quote by legendary investor Warren Buffet: 

"When people are fearful, be greedy!"  

When the market is down and everyone's panicking, that usually signals it's a good time to be invested.  

Crazy but true data point: $1,000 invested in 1980 when the chart above begins would've grown to $116,000 by now.  Despite the dozens of significant market corrections shown above, you'd have made 116x your initial investment if you just held on and did nothing.  You don't need to avoid market drops, you just need to avoid panicking.  

So to summarize:

1.  The longer we stay invested the better our chances of winning.  We get to be the house.  Stay focused on the long term.

2.  Stock market pullbacks are normal.  We don't have to avoid pullbacks, we have to avoid making bad decisions during them. 

3.  Forward returns are usually best at the same moment that things feel the worst.  The market pays you for your patience during a panic, so stay invested.


Adherence to these principles was evident if you look back at my video updates during the COVID Crisis of 2020 and the Bear Market of 2022.  At no point did I ever suggest getting out of the market or stoke the flames of fear.  My updates were focused on acknowledging the market volatility while encouraging folks to stay calm, patient and invested and avoid making an emotionally charged mistake.