Strategy Session: Keep The Cash Bell Ringing

Pop quiz: how much money can you expect to make with a simple buy-and-hold index fund strategy? I’ve been doing some calculations and while the answer isn’t bad, it isn’t exactly spawning a lot of fresh billionaires either.

Over the past century (give or take a year), the S&P 500 has moved up almost 8% a year end to end, or about 6% a year if you were to compound the gains. That’s it. Add dividends and you might conservatively look forward to 10% a year.

That’s not bad. It’s better than you’ll get in CDs or money markets, and if you were to lock in even half that level of long-term income in the bond market, it would be a clear sign that the economy is in terrible shape.

More importantly, 10% is enough to cover any required minimum distributions from your retirement accounts without dipping into your principal or depressing its buying power after you discount for ambient inflation. Over the long haul, the market as a whole tends to replenish itself.

These numbers have held up across the decades, across recessions and recoveries, boom and bust. I ran the statistics in the wake of the 1987 crash. I ran them after Lehman Brothers died. Same thing. There’s clarity in statistics.

But as we all know, the market is volatile and while the extremes average out to a reasonable positive number in the long term, any given year is likely to be anything but “average.”

The good years are great, rewarding investors with windfall 30-50% wins. The bad years can easily wipe out an equal fraction of your capital and wreck your nerve . . . and while only the S&P 500 only goes down 1 year in 3, the memories leave deep scars on investor confidence and significant holes in bank balances as well.

One bad year can scare people into the relative “safety” of bonds and cash, which historically barely even cover inflation but provide some sense of security. In the bond market, you rarely make enough money to get ahead, but you can eke out a living . . . and you rarely experience a whole lot of risk either.

So maybe you’re comfortable with the extremes in the stock market leveling out over time to give you that 10% annual return. Again, a lot better than bonds or cash. If you reinvest the dividends and resist the urge to sell the dips, you’ll probably double your money every decade or so, maybe a little slower if the market mood gets rough.

For young workers decades away from retirement, that’s great. Time in the market is all it takes to accumulate a healthy nest egg. But those of us who want something more ambitious just can’t settle for that slow glide.

After all, asset prices spiral up and down forever but the time you have in your market career is fixed. Sooner or later, you will run out of time to trade.

I’ve been in the market for about 35 years. Warren Buffett has been running Berkshire Hathaway almost double that amount of time. While I won’t rule either of us out for years to come, you can see how life imposes hard limits on the length of your time in the market.

Given those limits, every investor faces a real choice. You can always settle for a known return profile and earn so many percentage points a year. Sometimes those points are guaranteed. Sometimes it’s just a statistical assumption.

Or you can reach for something better and abandon the “random” walk in exchange for something where you have a bit more control over your own destiny. There’s risk here. You might get it wrong or for no fault of your own the market turns against you anyway.

But some of us really do have the courage, the insight and the discipline to try for realistic outcomes above 10% a year. I tend to rely on speed with my trading services. The goal is to slice the 365 days a year you’d be holding an index fund into segments where your money can work harder.

It’s basic math. The more time you spend in accelerated gear, the higher the ceiling is on the returns you can generate. Play it right and those returns compound, trade after trade. As long as the net performance per trade is positive, the numbers stack up extremely fast.

Look at my 2-Day Trader. In the past 6 months, we’ve carved 30 short-term options trades out of the market noise. They weren’t all winners but our persistence earned us 4.56% more than we lost on every trade.

That’s practically what you’d make in the money market right now in a typical year. We did that in just one trade. Then we did it again and again, at the rate of 60 times a year.

And we held one trade at a time so you can see how the money compounds. Here’s the fun part: we were only in those options a total of 50 days and as you know, a 6 month period has about 180 days in it. (Yes, I’m counting weekends.)

In those 50 days, we were making the equivalent of 7.596% a day. Meanwhile, we had the rest of the time to deploy other market strategies, park in money markets and enhanced cash funds and otherwise figure out how to stay ahead.

How did the random walk do? In the last 6 months, the S&P 500 is up 7.53%.

The way I see it, 2-Day Traders worked a little harder and captured a similar return in a fraction of the time. That’s acceleration. Make the most of every day the market gives you. Keep your money working as hard as you can.