Stock Market Basics

Any retirement plan is very likely going to involve stock market exposure. Stock market exposure can be as simple or as complex as you want to make it. This post will just have a simplistic introduction to the numbers.

I think that the back drop to your thinking about stocks is that the stock market averages about 10% per year through all sorts of feast and famine. It is unrealistic to think you will do much better than that. If you do end up with better than 10% per year, great, but don’t expect it.

If that is the average over long periods of time, and it is, you could pick some sort of allocation that is very broad and not change the target for years. For example, take an allocation of 55% in domestic stocks, 25% in foreign stocks and 20% in fixed income. If and when those numbers grow out of balance you could buy and sell to get back into balance.

A 50 year old with that allocation with 15 years to go until retirement starts, might change the 55/25/20 mix in eight years or ten years to 50% domestic stocks, 20% foreign and 30% fixed income.

With that, or any, mix there will be years where your portfolio beats the S+P 500 and years where your portfolio lags. Just as a function of how markets work, a reasonable growth target and a long time horizon can be met with a very simple set it and forget it.

I don’t advocate doing this but the point is that if you don’t care about beating the market and more importantly don’t care about volatility it can be this simple to keep reasonably close, either way, with the market over long periods of time.

Most people cannot, emotionally, watch the market cut in half without selling even though the numbers say they can. To point out what I mean, every crash before the tech bubble took back the old highs after some period of time. The current all time high has not been taken back yet but at some point the S+P 500 will print above 1500 again and then at some point it will see 1600 and then 2000 at some point in the future.

I don’t know when that will be. I might guess correctly when, but probably not. Same goes for you. But think about the last ten years, with all of the greed and misery people have suffered. It has been a full ten years.

On January 31, 1996, the S+P 500 closed at 636. Despite all of the intensity in the last ten years you have a double just by gritting your teeth and watching. Not only do you have a double, you could have gotten that double without being right about anything. Importantly, that 100% is much more than what inflation has been in that time which is why people own stocks, to beat inflation.

I think investors give themselves a chance for better numbers, just a chance not a guarantee, with a little bit of study and trying to get a couple more themes right than they get wrong. If you have no confidence in yourself to get anything right, which is OK, then train yourself to invest like an emotionless robot. I am not joking. If you don’t want to spend the time or don’t think you can succeed at analyzing big themes, focus on having no emotion whatsoever. I think this can be achieved by studying stock market history over and over.

This post was not meant to be all encompassing. The idea is to begin to understand how the numbers work and that the stock market can work for you without much effort on your part. I don’t mean to trivialize the difficulty of removing emotion from your thinking but a thorough understanding of the numbers and unyielding faith that markets work a certain way gives a chance for success to anyone who is not that bright. Personally, I take the under on my intelligence and my ability to get things right, admittedly I do this against more moving parts than what I have outlined in this article but I think the idea holds up.

I will have more about equites in subsequent posts.