The F Word

No, not that F-word.  I’m talking about fear.  Fear of missing out.  Fear of losing money.  Fear of investing in stocks, real estate, or a business. The type of fear that the phrase “past performance does not guarantee future results” creates.  That type of fear.

financial fear

Fear!

How Fear hurts you

Fear loves messing with people’s personal finances in a myriad of ways:

  • Fear of missing out: All my friends are going to Vegas for a weekend.  If I don’t go, I’m going to miss out on stories of a lifetime.
    • Result: Exceeding your budget
  • Fear of loss: I don’t want to invest in the stock market.  What if I lose money?
    • Result: Losing out on the positive effects of compound interest.
  • Fear of embarrassment: If I start my own business/blog/company and it doesn’t do well, it will be a waste of time and people will judge me.
    • Result: Never knowing what it’s like to be a successful business/blog/company owner.

One of fear’s favorite pastimes is paralyzing you from taking action.  The ironic thing about this is that the longer you delay, the less likely you are to succeed.  Getting started is often the most difficult part in any endeavor, whether it be opening up a mutual fund, buying your first investment property, or starting your own business.

In addition to fear paralyzing you from taking action, it can also push you to take action in all the wrong ways–especially with investments.

financial stressFear and stock market returns

I am a huge believer in the power of low-cost index funds, so I’d like to address fear of the stock market specifically.

When I graduated high school, I had hit a big milestone in my life: I had saved enough to open a mutual fund.  After doing a lot of research, I thought the S&P 500 was a sure bet, so I plowed what was nearly my life’s savings into it.  That was the summer of 2006.  In just a few years, I saw my life’s savings cut by 40%.  Cue feelings of regret.

Who hasn’t heard the phrase “over the long-term, the stock market returns 8%”?  Well, in 2008 I wasn’t buying it.  Thankfully, I stuck it out and kept contributing to the mutual fund.  It ended up paying off when I saw every dollar I invested in 2010 double after five years.  My annualized rate of return shot up to an impressive 12%.  Had I let fear take over and pulled money from my mutual fund, I would have locked in the losses I experienced and missed out on fantastic future returns.

Going back to that 8% return that everybody told me I would see.  Where does that number even come from?

I love math and when faced with some sort of financial question or decision, I turn to the numbers.  I set out to find how this “median” return on stocks came to be.  Is it even true?  Nobody seems to show data.

I’m going to give you data.

When Robert Shiller, a Yale economist, wrote  Irrational Exuberance, he posted a spreadsheet that contains the monthly price of the S&P 500 since 1871.  You can find the data here if you are interested in looking at it.  The beautiful thing about this data is that it contains prices that are adjusted using the Consumer Price Index so that they are real. Sweet!

Using this information, I calculated the real, median annual return for every possible 12-month period since 1871.  I don’t mean January 1871 to January 1872, then January 1872 to January 1873.  I calculated the return for Jan 1871 to Jan 1872, then Feb 1871 to Feb 1872, and so on.

The real, median return came out to a measly 4.1%.  Ouch.  This is nowhere near the 6-10% you usually hear about!  But wait. What about dividends?  Dividends need to be included too if you’re reinvesting them (you better be!).  It turns out that the real, median dividend yield is 4.3%.  This is somewhat interesting, considering recently it has been below 2%.

When we add the 4.1% appreciation to the 4.3% dividend yield, we get a nice 8.4%.  That is a return that accounts for inflation and is more than two percentage-points higher than the conservative 6% I use for calculations on this blog.  I made the spreadsheet I used for these calculations available publicly, here.  Check my math!

So if the median, real, annual return is 4.1% without dividends, how many times do we see a return like this year after year?  The answer: not often at all.  In fact, I’d argue that we see returns other than the median way more than the median itself.  Check out the histogram below which shows how many times the market returned a certain percentage in every possible 12-month period since 1871:

fear personal finance

As far as the stock market goes, the short version is this: don’t flip out when you experience negative returns for a while.  Stay your course!  This philosophy is applicable to life in general: marriage, friendships, your career, and just about everything has its ups and downs.

When the poop hits the propeller, take a deep breath.

Conquering Fear

Start off by finding out where fear affects your personal finances.  Not sure where it does?  Pull up all of your accounts on one screen using something like Personal Capital.  Financial fears can be spotted easily by simply examining your accounts.  It manifests itself in dollars–or more frequently–the lack thereof.

High credit card debt could be a result of a phobia of missing out.  Low investment balances could also be a result of fear-of-missing-out or they could be a fear of suffering negative returns.  If your money is low across the board, then perhaps it is time to start thinking about your career or starting your own side gig.  Don’t let the fear of change or failure suck you in and hold you hostage to your routine.  Plunge in.  Make mistakes and learn from them.

This is an exercise that requires some serious introspection.  Only once you’ve identified what is driving your personal finance blunders, can you take steps to improve.

Action Items
  1. Pick a fear, any fear.
    • Not sure what type of fear is driving your decisions?  Analyze your account balances.  If something is lacking, that’s called a “clue”.
  2. Get moving

 

 

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