Instead of providing refuge, bond ETFs are just slower sinking ships, which can be concerning for millennial investors.Drazen_/iStockPhoto / Getty Images
Luke Reynolds, 33, freaks out a little bit every time he looks at his portfolio online. The newly married dental practice development consultant started investing in 2020, adding a total of $42,500 to his portfolio of exchange-traded funds (ETFs). Today, that portfolio is valued at about $31,413.
“I love the idea of buying ETFs,” Mr. Reynolds says. “But it’s terrifying to watch the more sure-fire investments decline quicker than they have ever risen.”
Many investors can relate, especially as many stocks with some of the highest hopes have fallen the most. Consider Shopify Inc.’s 76 per cent year-to-date drop, which has helped to drag down the iShares Growth Index ETF (XCG-T) by 13.8 per cent so far this year. (Performance data as of July 13). The meltdown of some of America’s most popular technology stocks, such as Facebook (now trading as Meta Platforms Inc.), Tesla Inc., Amazon.com Inc. and Apple Inc. has sent the iShares Nasdaq 100 ETF (CAD-Hedged) (XQQ-T) down 27.6 per cent year to date.
Instead of providing refuge, bond ETFs are just slower sinking ships. Vanguard’s Canadian Government Bond Index ETF (VGV-T) has dropped 12.5 per cent so far this year, while Horizon’s swap-based Canadian Select Bond ETF (HBB-T) plunged 12.4 per cent over the same period.
Investors who see this as problematic may wish to recall Warren Buffett’s rule of thumb: anyone adding money to the markets for at least the next five years should prefer to see stocks sink, not rise.
To put the market mayhem in context, I asked Mr. Reynolds to consider two scenarios based on two different 21-year periods.
Scenario 1: The S&P 500 sees an average annualized return of 9.3 per cent over the next 21 years. The first three years see huge, consecutive gains of 37 per cent, 22 per cent and 33 per cent respectively. This happened from Jan. 1, 1995 to Dec. 31, 2015. The first three big years were 1995, 1996 and 1997.
Right away, Mr. Reynolds said, “That sounds pretty good. I would see immediate returns and a high, overall average.”
Scenario 2: The S&P 500 averages 6.5 per cent per year over the next 21 years. The first three years see huge, consecutive calendar-year drops: losing 9 per cent, 11 per cent and 23 per cent respectively.
These numbers represented the S&P 500′s actual returns from Jan. 1, 2000, to Dec. 31, 2020, including massive losses in the first three years: 2000, 2001 and 2002.
On the surface, scenario 1 looks better – but not so fast.
In fact, scenario 2 should make younger investors – or anyone with a longer-term investment horizon – celebrate. Throughout history, globally diversified portfolios always recover from market plunges – and then hit new heights.
That’s why new investors with diversified portfolios of ETFs should be excited to see stocks fall. It’s an opportunity for them to buy funds at lower prices. When investors stockpile such assets at a discount, those assets soar as markets recover.
Using portfoliovisualizer.com, we can see how each scenario would have played out for Mr. Reynolds. (Since it’s an American website, the numbers are calculated in U.S. dollars):
In scenario 1, Luke adds $1,500 a month to his $31,413 and stocks soar for the first three years. With an average annual market return of 9.3 per cent over 21 years, Luke’s money grows to $1,074,795.
In scenario 2, Luke also adds $1,500 a month to his $31,413 and the market drops for the first three years. Over 21 years, the market’s average annual return is 6.5 per cent, and he ends up with $1,431,047.
Why does he earn more on a lower average return over the same period?
It’s because stocks dropped for the first three years. By simply doing dollar-cost-averaging (adding the same amount to your investments every month) big discounts in the early years would have allowed him to pay a lower-than-average price for his investments over time. This would have increased his money-weighted return, which is the only return that matters.
This doesn’t mean you should hold cash and only invest when stocks fall or when you think interest rates or the economy will send you a signal. That’s market timing. It almost never works; it certainly never works twice.
Instead, if you have money, invest it now. If you earn money every month, ignore all economic forecasts and keep adding money. It’s a rare treat to see stocks and bonds on sale.
As a 52-year-old with an income, I’m thrilled to see the discount. As for young people with money to add (whether a lump sum or something to add every month) they should be throwing parties now and dancing in the streets.
But be kind. Rising markets are better for retirees. So, if a retiree sees your celebration and asks what’s going on, just tell them you got a raise. Technically, if you’re a long-term investor, it will most likely turn out to be true.