It's been a turbulent few years for investing. Traditional paradigms have shifted like sand after a storm, while pundits preach that those traditional ways of investing are dead.
In reality, nothing could be further from the truth. The tried and true philosophy of diversification, low costs, and rebalancing continues to work but, more importantly, worked especially well over this period.
Take the simple three fund portfolio. To survive the financial meltdown, all one would have needed to do was stay the course and Dare to be dull* by building a simple portfolio and rebalancing at the end of each year.
If you had used this simple and not so secret formula since 2006, the conservative portfolio (30 percent equities) would be up 15.8 percent as of September 24, 2010. The moderate portfolio would be up 7.1 percent, and the aggressive portfolio would only be down 4.1 percent.
I measured beginning in 2006, so I could show the high water mark for markets and where we are now, versus the highest year-end close ever for financial markets - 2007. As you will notice, the conservative portfolio is 11 percent higher than the 2007 mark, while the moderate is up a fraction. As bad as financial markets were, even the aggressive portfolio, appropriate for perhaps only a second grader, is merely down 12 percent.
As mentioned, the formula is simple and available to anyone that wants to use it. This formula requires that we "dare to be dull." What does this mean? Let me start with the dull and then I'll get to the daring.
Investing should be dull
Nobel Laureate, Paul Samuelson, said it best.
Investing should be dull. It shouldn't be exciting. Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.
Well, these three index funds certainly meet the dullness criteria. You'd have to look far and wide to find funds that are less exciting. And this presents an unexpected challenge to investors. It's hard to strike out for dull and boring, when our emotions, along with the media and Wall Street, are singing their siren's song of what the economy will be doing and where to invest. Fantasies of outsmarting the market are the rocks the sirens entice us to wreck our ships on, and, naturally, our advisors are willing to charge us handsomely to try and do it.
The temptation of trying to outsmart financial markets is practically impossible to resist. Yet, in reality, it's simple arithmetic people are trying to outsmart. And, far from being alone in this pursuit, 90 percent of investors think they are beating the market. Unfortunately for that 90 percent, it can't happen.
Few dare to be so dull
The other challenge to "dare to be dull" investing is the fact that few have the intestinal fortitude to pull it off. That's because it requires rebalancing, and rebalancing pushes us to go against the herd. Let me illustrate how this would play out in the real world. In 2007, after a fifth year in a row of stock market gains, rebalancing to our target allocations would have forced us to sell some of our stocks. And at the end of 2008, after the so called "death of capitalism," rebalancing would have required us to buy stocks.
Admittedly, even for a rebalancing fan like myself, it was very difficult for me to buy equities in late 2008 and early 2009. Watching my nest egg drop like a stone was as painful for me as any other investor. Yet buying stocks at the half off sale turned out to be the right thing to do.
Desperate times call for desperate measures, and during those 2008/2009 desperate times, every instinct in my body screamed at me to listen to Cramer when he told viewers to get out of stocks after the collapse. Or listen to the proactive radio guru when he told his mom to get out of stocks. "Maybe they're right," my instincts kept saying, maybe it is the great depression ahead.
"Buy, hold, and rebalance" took quite a beating by the experts in 2008 and early 2009, but ultimately prevailed yet again. "The new normal" revealed itself to be as silly as the beliefs that caused the crash in the first place, such as the ever-so-silly belief that real estate values can never decline.
One of the few predictions I can make with certainty is that experts will be giving us new paradigms on how to invest our nest egg. Ignore them! If your portfolio isn't above its 2007 year-end close, maybe you now have the guts to try this simple and boring technique. I dare you to be dull!
* Note: My lawyer requires me to note that "Dare to be dull" is a registered trademark.