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Market Perspective
Virtues to Invest By
 by Ernie Ankrim, Ph.D.
Chief Investment Strategist
Frank Russell Company
March 18, 2003
This article has been provided by our parent company, and primarily deals with the US market.
What makes a successful investor? How about a slice of humble pie? Honesty, humility, discipline — traits to aspire to in daily life. Yet when it comes to investing, many of us apply principles such as risk and reward, and may fall prey to temptations such as greed, although we may not admit it. When we check what the market did, we don't think about admirable characteristics — we want to know how much our investments made or lost. But the values that influence our daily lives also apply to investing. Consider my five virtues to invest by:
Humility — Accept Reasonable Rewards for Reasonable Risk.
Are you disappointed if you don't see "great" returns every quarter? Reflect on the real-life example of Long Term Capital Management, a US-based mutual fund. As reported in a 1998 Wall Street Journal story, during 1995 and 1996, the LTCM fund generated returns exceeding 40%. Investors were ecstatic while others scrambled to get in. But in 1997, thanks to market volatility, returns dropped to 17.7%. Reasonable, yes, but not phenomenal and not what investors had come to expect. And then came August 21, 1998, when the market plummeted. LTCM's investors experienced returns of -50%, a staggering loss. Long Term Capital Management partners lost nearly US$1.6 billion.1
The lesson of LTCM, unfortunately, isn't unique as many investment products have seen performance dive amid a three-year market correction. The evidence should teach every investor: staggering returns come with the risk of losing a lot of money. So exercise humility. Be humble enough to accept reasonable rewards in exchange for taking less risk.
Honesty — Recognize that the person with the most wealth at the end is not necessarily the winner.
Sophistication and risk tolerance are not synonymous. Just because your knowledge of investing is high doesn't mean your risk tolerance is.
It's easy to get greedy in a bull market. But that type of environment left many investors unprepared for the wide-spread troubles dogging global equity markets since March 2000. Be honest with yourself about the trade-off between return and risk. In your quest for hot returns, are you willing to risk a year when you may lose a sizable portion of your investment and earnings?
Take my wife, for example. When we carpool to work we pass an outdoor electronic ticker that shows how the Dow Jones Industrial Average is performing. When the Dow's up she never says a word, but when it's down she's immediately concerned. She knows about the markets, yet she's anxious when her investments decrease in value. In the long-term ride to wealth accumulation or preservation, an honest confrontation of risk and reward is the only way to prepare for unpredictable volatility.
Poise — Recent winners could be tomorrow's losers.
Do you question your investment strategy based on what you read or hear in the news? Consider the lists compiled by Morningstar, Inc., of America's 15 best and worst performing growth mutual funds in 1996. Amazingly, seven of the funds appeared on both lists. For example, the Dreyfus Aggressive Growth Fund registered an impressive 67% gain between January and May 1996 — making it the top performing growth fund the first five months of that year. But, between June and December, the fund fell 30% — making it the nation's second worst performing growth fund during the last six months of l996.2Maintain your poise in the face of market volatility. Accept that the value of your investments will rise and fall in the short term based on market behavior. And that's OK because what matters is the size of your account balance on retirement day.
Commitment — Keep your eye on the prize and ignore short-term market events.
History shows moving in and out of the market may reduce return, so don't bail out. Consider a "sticker," a hypothetical investor who started investing in a portfolio of 60% stocks and 40% bonds in January 1960 and stuck with it through December 1994. His average annual return would have been 9.47%. Now consider a "bailer," a hypothetical investor who starts out with a 60/40 strategy in 1960, but who tries to time the market by periodically bailing from stocks to bonds. During the same time period, this investor would have changed the allocation of his portfolio to 20% stocks and 80% bonds on 21 occasions for a total of 87 months, or 20.7% of the total time period. In 1994, his average annual return would have been 8.26%.3 Our "sticker" fared much better.
Hopefully your investment strategy was selected based on your risk tolerance, age, how long you plan to work, financial circumstances, retirement goals, and attitudes about investing. Stay committed to your strategy and don't alter it unless your life changes.
Discipline — Don't be ruled by consumption.
We live in a spend-happy society. We spend often without considering the consequences. Instead of setting money aside continuously, we count on the markets to balloon what we've already saved in order finance our retirements. But remember, exceptional investment performance cannot replace a sustained savings effort. Conversely, a dedicated savings effort may lead to a substantial accumulation of wealth independent of external factors such as market volatility.
Imagine a hypothetical investor with a US$30,000 income, who sets aside 2% of his income annually each quarter ($150). If his return on these funds matched the S&P 500® over a 25-year period (from the 4th quarter 1974 through the 3rd quarter 1999), he'd have accumulated US$164,805 by the end. Now imagine you had to choose for this person either: 1) the ability to select investments that would beat the market consistently by 5% per year, or 2) the discipline to set aside 8% of his income ($600 every quarter). Which person would end up wealthier? In the graph below the answer in obvious. The phenomenal investor would have accumulated US$417,562 but the outstanding saver would have accumulated US$659,222.
The hypothetical example is for illustration only and is not intended to reflect the return of any actual investment. Investments do not typically grow at an even rate of return and may experience negative growth. It is not possible to invest directly in an unmanaged index such as the Standard & Poor's 500 Stock Index.
Baseline: Invests 2% annually ($150 per quarter); Returns match S&P 500
Great Investor: Invests 2% annually ($150 per quarter); Returns beat S&P 500 by 5% per year
Great Saver: Invests 8% annually ($600 per quarter); Returns match S&P 500
Saving may not be as exciting as looking for the next "secret to the market" in the hopes of increasing returns, but it does pay off. The discipline of forgoing spending and investing the proceeds is the most reliable way to accumulate wealth.
It is important to stress that this example was not meant to equate saving with putting money into bank deposits. "Savings" in the illustration simply means the act of setting aside, rather than spending, some of one's income.
The Point — I'm not suggesting these simple virtues will make you wealthy.
I'm merely offering that one's approach to investing can be handled with the same grace we strive for in other aspects of life. So run through these five virtues in your mind the next time the market nose-dives or you're tempted to act on a "hot tip" from a coworker. As Socrates said, "Virtue does not come from wealth, but wealth, and every other good thing which men have, comes from virtue."
1Wall Street Journal article, "All Bets Are Off," November 16, 1998, pages A1, A18, A19.
2Fortune Magazine, "The Mighty Fall," John Wyatt, January 13, 1997, pages 156-158.
3Change to 20% stock/80% bond allocation would occur in months in which the previous 24 months' equity/bond risk premium has fallen below -2% per year. The 21 occasions of 20% stock/80% bond allocation would have been: 7/62, 10/66, 1/67, 2/70, 5/70 to 7/71, 9/71 to 1/72, 1/74 to 1/76, 6/77 to 7/77, 2/78 to 8/78, 11/78, 1/79, 3/82, 8/82 to 6/83, 8/83, 7/85 to 11/85, 7/89 to 10/89, 10/91, 12/91, 7/92, 6/93, and 8/93. Based on Russell Research Commentary, "Don't Bail Out: The Value of a Disciplined Investment Philosophy," Dr. Ernie Ankrim, Frank Russell Company, June 1995.
Article is based on the research report, "Characteristics of Successful Investors" developed by Dr. Ernie Ankrim, Frank Russell Company, 1999.
Copyright Frank Russell Company 2000. All rights reserved. Important Legal Information. Date of first use: 4/26/00.
This is a publication of our parent, Frank Russell Company. It should not be construed as investment, legal, or tax advice. The contents are intended for general information purposes only, and you are urged to consult your own investment, legal, or tax advisor concerning your own situation and any specific investment questions you may have. For further information about these contents, please contact Russell Investments Canada Limited.
Unless otherwise noted, all references to stock performance are represented by Standard & Poor's 500® Stock Index. Bonds are represented by the Lehman Brothers Aggregate Bond Index.
The rate of return table shown is used only to illustrate the effects of the compound growth rate and is not intended to reflect future values of any specific investment.
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