I like index funds. And the more I analyse historical data, the more I like them. Currently, I have poured over the data from the NZX-50 from the last 69 years. That includes that data for when it was the NZX-40.
This got me thinking, what if you were the worst investor ever?
So let’s have a look.
Let’s imagine that you were the worst investor ever. You don’t know anything about the market and aren’t worry about timing either. You invest your money when you have saved enough. You knew that you had to start saving for retirement. Once you finished training and started your career say in 1972, you began investing at age 20.
Like me, you invest in low-cost index funds. The fund you chose was an NZX-50 index fund with a 0.3% fee, like the ones offered from Simplicity.
You planned to start by investing $5,000 in 1972. And you planned to keep investing every few years until you would retire at the age of 65 in 2017.
As your income increases, you plan to invest more. Your first investment was at the end of 1972, when he invested $5,000. It was a great time to start, and the NZX-50 had returned 21.6% over that year.
So all your money went into an NZX-50 index fund at the end of 1972.
The market dropped by -14% in 1973, and by another -6% in 1974, you put your money in at the peak of the market right before a crash. After this experience, you backed off investing for a while until the end of 1975, when you invested another $10,000- the market had returned 8% the year before you thought.
The market dropped another -7% the following year. This spooked you from investing in index funds for a while.
You left the money invested, as you didn’t want to withdraw it. You knew if you withdrew the money, the loss would become real.
You didn’t feel comfortable to invest again until the end of 1986- 11 year later. You saw that in 1985 the index had a record year at 72% return. By this stage, you had saved $48,000 to invest with. Again, you timed it wrong and the market drop -38% in 1987.
This trend kept happening for your entire investing life.
Investing another $15,000 in 1988, $85,000 in 1997. Both times your investments were followed by a large drop the following year, -19% in 1989, and -15% in 1998. You held back investing again until 2007 investing $100.000 of your hard-earned cash.
After all, you were 55, and your retirement was coming up fast. But you bought right before another large crash of -33%.
To recap, your investment timing was terrible. Buying index funds at the market peaks just before extreme losses. Here are the purchase dates, the crashes that followed and the amount you invested at each date:
|Date of Investment||Amount Invested||Subsequent Crash||Initial Losses|
Yet you did have one saving grace. Once you had invested in the index fund, you never sold your index fund shares. You held on because you were scared about being wrong on both the buy and sell decision.
Remember this lesson because it’s a big one.
You never sold a single share.
So how did you do?
Even though you only bought at the very top of the market, you still ended up a millionaire with $1.01 million to retire on. Below is a graph of his investment in the NZX-50 index fund.
How could that be you might ask?
You invested right before every major crash since the ’70s, yet you still came out ahead nearly quadrupling your money. How did you do that? First of all, you had a hold mentality. You knew that you shouldn’t withdraw your funds. Ever.
You allowed your investments to compound through the decades by never selling out of the market over your 40+ years of investing. Secondly, you were a diligent saver and knew that you had to invest your savings. You never wavered on his savings goals and increased the amount you saved and invested over time.
Over your investment life, you did have to endure a huge psychological toll from seeing large losses after investing your hard-earned money. But you stuck with it as you had a long-term mindset. You continued to save and kept investing every few years.
And finally, you knew he had to use a straightforward and low-cost investment plan. You knew fees could eat at your profits over time. Obviously, this story is for illustrative purposes on what could happen if you invest at the worst possible time. I wouldn’t recommend investing only in one index fund.
Even then, if you had a more diverse set of investments you could time the market wrong for all of them.
To avoid this, you could use an investment technique called dollar-cost averaging where you invest annually every year. No matter what the index fund is doing. In the above scenario, you invested a total of $260,500. If you invested this amount evenly every year, it would be an investment of about $5,600, or about $110 per week. What would your investment look like then?
Using the dollar-cost averaging you would come away with over $2 million dollars when you retire. Nearly 8 times your initial investment.
Lessons from this story:
- You are going to make investment mistakes. We all are. You should make sure that you have an optimistic outlook for the long-term. Thinking long-term is the key after all the market has averaged 7.8% over the last 69 years.
- Unless you think the world will end or innovation has stopped, you should always be optimistic about the future. Winston Churchill once said, “I am an optimist. It does not seem too much use being anything else.”
- Losses are a part of dealing with investing in index funds. How you deal with these loses sets you apart from other investors.
- Save more, think long-term and let compound interest do its thing. You don’t need to pick the best index funds or time the market.
***This whole scenario is made up for illustrative purposes using data from the NZX-50 and an index fee of 0.3%, and average returns for the years 1972 until 2017.
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