Why the “Five-Year” Rule?

6/29/22 – Previous Close: DJIA 30,947; S&P 500 3822

For longtime readers of these market letters, my “Five-Year Rule” is very familiar. The phrase “Always be (at least) a five-year investor” has been in many of these letters and hundreds of conversations and presentations over the past 10+ years. The Rule is applied in every new client interview. I simply cannot bring myself to take on a client who cannot commit to leaving their money invested for at least five years – because I’m convinced that it is not in their best interest. (Withdrawing a reasonable monthly income or for an occasional “need” does not violate the Rule.) So, with the market in yet another “bear market” (the seventh of my 36+ year career), it seems a good time to explain why this Rule is so important to me and thus my clients’ long-term success.

I openly acknowledge that I lean more towards equity investing (versus bonds) than many other folks in my profession. Why? Because, in the long run, stocks nearly always do better than bonds! My clients want higher returns (no kidding) and stocks are usually a great vehicle for providing that. BUT those higher returns don’t come without a cost. One of my favorite investing quotes is:

The “price” you pay for the higher returns that stocks have delivered over time is the uncertainty of “when” those returns will come through and the volatility of the journey.

It would be great if higher returns could occur like clockwork – consistently, smoothly, and every year. That is simply not reality. The length of one’s investment time horizon makes a huge difference in their “success”. An analysis by JP Morgan dating back to 1950 reveals that of the past 72 individual years through 2021, the stock market returns (S&P 500) have ranged from a best year of +47% (fun!) and a worst year of -39% (ugh!!). However, looking at the five-year returns (68 opportunities) shows a far different story. The best five-year period provided an average annual gain of 28% per year - sweet! But the worst was a loss of only 3% per year! In my opinion, assets that cannot assume the risk of a 3% per year decline (in hopes of making a solid return) ought to be in savings rather than investments.

During most five-year windows, the market will have a great year, a bad year, and some inbetween years. Let’s look at our current five-year period beginning in June 2017. Think about what has transpired! In 2018 we had a trade war brewing and the market fell 19.9% during the last quarter of the year. (This is not counted as one of my seven, but it was pretty darn close!). In 2020 COVID showed up and knocked the market down 34% in only five weeks!!! Now, in 2022, the market has fallen 23.6% from its all-time high, though it has regained some of that. So, in five years, we’ve seen declines of 20%, 34%, and 24% -- so how has the five-year period been in total? What if, in June 2017, an investor went on a 60-month vacation with no access to market news and came back today – and didn’t know the market had fallen 20+% this year? Would they be pleased? Since every investor’s situation and portfolio makeup is unique – with different risk tolerances and asset-allocations, let’s just use the S&P 500 for our calculation. Before you read any further, take a guess at how stocks fared during these past five years with three major declines. Up 10%? 25%? 50%? For the five-year period ending 6/27/22, the S&P 500 has returned 76.3%! Yes, it’s been a wild ride, but most folks would be delighted to have gotten half that much – especially given the current pullback.

Investors will soon receive their monthly or quarterly investment statements and will likely be pained at the decline so far this year. Remember, that’s only six months – out of 60 (five years). For clients that have been with us for over five years, we can demonstrate the power of the Fiveyear Rule. If you’d like, we can prepare a report showing your actual five-year results. For clients who have not yet been with us five years, take heart in the stats I’ve shared in this letter. Not every five-year period is positive – but most are and the ones that aren’t have historically had only minor losses.

One more comment: When determining your investment time horizon, it is not when you are going to retire or even pass away. It is when someone (you or your heirs) will want/need to withdraw a substantial portion of your assets (25-50%) all at once. If this explanation makes you realize that your time-horizon is shorter than five years, please give us a call. And finally, about those seven bear markets I’ve seen in my 36+ year career (7.9 if you include 2018):

  • Each one had a different cause/reason – war, rising interest rates, a pandemic, etc.
  • Not a single one was fun!!! I’ve been unnerved every time!
  • At least so far, after every bear market, the market fully recovered all its losses and went on to reach new all-time highs – in fact, much higher.

Yes, the Five-year Rule is vitally important to our clients’ financial and emotional well-being!

H. L. Ormond & Company, LLC (“HLO”) is a Registered Investment Adviser. HLO offers advisory services only to clients or prospective clients where HLO and its representatives are properly licensed or exempt from licensure.

This information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of HLO and are subject to change without notice based on market and other conditions. Diversification does not assure a profit or protect against a loss. Keep in mind that individuals cannot invest directly in any index. Individual investor’s results will vary. Past performance does not guarantee future results.

The information used in this market letter has been obtained from third-party sources considered to be reliable, but we do not guarantee that the material is accurate or complete. Investing involves risk and you may incur a profit or loss regardless of strategy selected.

The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow,” is an index representing 30 stocks of companies maintained and reviewed by the editors of the Wall Street Journal. The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 22 developed nations. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represent approximately 8% of the total market capitalization of the Russell 3000 Index.

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