It is a well-known phenomenon that most investors underperform even their own investments as they have a tendency to move in and out of their investments at the most inopportune times. The consequence of this poor investment behavior is that much wealth is left unrealized, especially by those in lower income tiers, and wealth inequality is thereby exacerbated.
Even knowing this about poor average investment returns, it is still shocking to read of the damage that poor investment behavior has done over the most recent cycle. A recent Wall Street Journal article on the subject noted that some 5.4 million households completely exited the stock market during the bottoming process of 2008-2009. Even though the S&P 500 has generated a greater than 300% total return since the market low of March 2009, a Federal Reserve study observed that the main beneficiaries of the bull market have been the wealthiest:
Source: Federal Reserve
A main reason the wealthiest Americans survived the downturn and actually managed to grow substantially their net worth throughout the cycle is that they are able to be patient when the market is volatile. Unlike those in lower income brackets who may have to access their retirement resources well before they planned, the wealthy are able to take advantage of downturns to accrue to themselves the wealth that others are foregoing:
Source: Wall Street Journal
Graphics are certainly helpful in illustrating this point, but there is one anecdotal piece of evidence that I think does more to explain this phenomenon than any chart could.
By December of 2008, the S&P 500 had fallen some 40% from its October 2007 high, and shell-shocked investors were in full-blown panic. An astute company, however, sensed a tremendous opportunity. Elite Island Resorts, a company that specializes in luxurious Caribbean vacations, initiated a promotion in which they would accept the depressed stocks of 100 S&P 500 companies from their guests instead of cash. To entice further their clients, they offered to accept the shares not at the cratered values of December 2008, but at the much higher prices of July 1st, 2008.
For example, if you owned shares of General Electric, which closed at $15.50 on December 1st, 2008, Elite would give you credit for the shares based on the July 1st, 2008 value of $27.12, which was almost a 75% instant increase in the exchange value of your GE shares.
At the time, the New York Times quoted Elite’s then president, Steven Heydt, as saying:
“[Accepting stock] is a far better way for us to have a return on our investment. We all believe there is great value in the U.S. stock market. We are willing to wait for this market to turn around.”
Mr. Heydt was quite correct. While the S&P 100* dropped about 32% from July 1st, 2008 to December 21st, 2008, – meaning that Elite was essentially giving its patrons a 32% discount to the cash value of its normal rates, – the S&P 100 has since generated a total return of roughly 120% from July 1st, 2008, which means that even after the extra financial incentives Elite offered its patrons to tender their shares, it still made close to 100% on the exchange, assuming the shares were held through the bull market. By comparison, those who tendered their shares to Elite probably enjoyed their premium vacations, but their photographs and memories came at the price of a very steep opportunity cost.
In sum, the main advantage the wealthy enjoy is their lengthy time differential. As Morgan Housel has written recently,
“The most important question to ask when thinking about risk isn’t how much volatility or upside you’re looking for, but how much time your emotions and goals need for that volatility and upside to play out.”
Successful investors understand not only that time is an asset and an ally, but also that it is non-renewable. While most investors think in terms of risk and reward, great investors understand it is more a question of how and when.
*I was not able to access the full list of the 100 S&P stocks that Heydt accepted in its promotion, so I used the S&P 100 as a proxy.
Disclosure: The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index.
Clients of Fortune Financial own shares of GE.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Fortune Financial Advisors, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Fortune Financial Advisors, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.