The Speed Limit of Equity Investing

Many families rely heavily on a car in their daily lives. Visiting family, getting to and from school or work, and then on to sports events or lessons – the car and the roads we take it on are a major part of our lives. In our short essay today, we want to let car travel and traffic conditions be a metaphor to illustrate the long-term trend line of equities.

First, let’s look at history. The long-term trend line of equity investing rises up from the lower left to the upper right. The average return for equities after inflation is about 6.5 to 7% depending on which market you look at. Let’s call this trend line, or percentage return, the speed limit of equities. It’s the normal average return one has achieved by investing in equities over the long term.

Now I’d like you to think of the cars on a highway as individual stocks. We know that when we drive down the highway, where the speed limit is 100 KPH; there will be some cars that exceed the speed limit by a significant margin. Others stick close to the speed limit. The speeders are aggressive, take chances and tend to be more risky. The others take fewer chances, are less aggressive and tend to be less risky.

Speeders will get to their destination in less time. The others will take a little longer to get there. The speeder however also faces additional hazards. There is a risk of being stopped by the police. Then all the cars pass the speeder while he waits for a speeding ticket. This could likened to a corporate set back. It will take the company and the speeder some time to recover. However, this setback only affects the speeder. All other cars continue on their way following the trend line, or speed limit.

There may be other more serious hazards like construction, a snow storm, or a traffic accident that will slow down all cars on the highway. These obstacles can occur at any time. They are unavoidable and you must be mentally prepared in case they occur. A recession, terrorist attack or financial crisis could be considered examples of more serious hazards that affect all equities. Drivers as well as investors must be prepared at all times as these obstacles are unpredictable.

The equity market has seen a few serious hazards over the past decade and a half. Back in the late nineties we had a tremendous run up in equities. Most stocks were exceeding the trend line, or speed limit, to continue with our example. Then the Tech bubble burst in 2000 and all cars had to slow down. That hazard lasted about two years until the highway was safe for equities to again resume their long-term trend line. Then in 2007 the U.S. financial crisis hit. Once again the equity market was slowed down. Another two-year clean up was required.

All hazards eventually come to an end and traffic resumes its normal speed limit or trend line. Today many equities are travelling significantly below the long-term trend line, yet their products are in demand, they are well managed companies, and they are very profitable.

The goal of all drivers is to get to their destination safely and on time. Typically you don’t turn around and go back home when you encounter a hazard. You stick with your travel plans and continue. This is similar to a retirement goal. Stick to your plan, stay on the highway, and hazards will eventually be cleared for a smooth ride toward achieving your goal.

The foregoing is for general information purposes and is the opinion of the writer. This information is not intended to provide personal advice including, without limitation, investment, financial, legal, accounting or tax advice. Please call or write to Rick Sutherland CLU, CFP, FDS, R.F.P., to discuss your particular circumstances or suggest a topic for future articles at 613-798-2421 or E-mail Mutual Funds provided through FundEX Investments Inc.

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