My Desert Island Chart
What would I need to survive on a desert island?
Hmm.
I’m a man of few needs. I’ll assume the island would come with a few features I already cherish: a beach, endless palms trees (at least two!) and a right breaking wave.
But what could I not live without?
A water filter, a means to fish, and of course, my favorite chart: the long-term historical returns of stocks, bonds, cash and real estate.
Source: NYU Stern School of Business
*The returns here are calculated on a logarithmic scale in order to show volatility as well as returns.
The Desert Island Question has a way of forcing us to cut through the noise.
How much information can we take away from one picture?
With this one, lots. Here are a few of my favorites from this chart.
History As a Guide
I suppose I could’ve requested a crystal ball on the island. Until that arrives, history will serve as an imperfect but adequate substitute to plan for the future.
We now have over 150 years of reliable data for stocks and about 100 years for bonds. In some cases, data can be patched together to show returns dating back to the late 1700s. The Case-Schiller Home Price Index housing data goes all the way back to 1890.
Rich data = deep insights.
As fellow Missourian, Mark Twain, would say, “History Does Not Repeat Itself, But It Often Rhymes.”
Yes, market structures evolve.
Humans? Eh. Sort of but not really. Over time, investors waver between the extremes of euphoria and dread.
Erosion of Cash Due to Inflation
Draw a horizontal line across and there’s your cash data point.
Cash stuffed in mattresses or in a bank account yielding .01% does NOT preserve your money.
Inflation slowwwwly erodes the value of a dollar not generating any yield.
Your dollar today is worth less tomorrow thanks to inflation.
Cliffs and Hills
If you’re more of a visual person, you don’t need me quoting long-term historical average returns and standard deviation, the most common statistical metric to measure price volatility.
The less volatile, more conservative assets look more like rolling hills while US stocks offer a higher reward long-term. The catch? You must endure the jagged cliffs.
Zoom In vs Zoom Out
Perspective matters especially during the extremes.
You can celebrate 15-25%+ returns on stocks in a year but remember stocks over the long-haul return ~10% on average. What goes up by 20% can always fall by 20%.
Gratitude and cautious optimism are healthy. Euphoria typically leads to excessive risk-taking.
Fortunately, the worst of times, while painful in the moment, don’t last all that long compared to markets in an uptrend. A typical downturn in stocks, what pundits call a Bear Market, lasts about 13-14 months on average.
Stocks on an uptrend, or Bull Markets, can last for several years. The most recent bull market between the end of the Great Recession and the COVID pandemic lasted 11 years.
Bear markets are painful but short-lived. When you get queasy from daily or weekly market fluctuation, zoom out to appreciate the longer-term trend.
Point of Indifference
How much risk should you take in your portfolio?
Setting aside your attitude towards risk, I’m going to use the point of indifference framework to illustrate how a perfectly unemotional investor would approach risk and return.
I’ve written about how each dollar in your portfolio should have a job. The point of indifference simply means each savings goal has a defined amount and future date when it’s needed.
If cash is needed in the short term, low-risk investments like bonds or high-yield savings accounts are ideal.
After all, if you invest in an all-stock portfolio for a savings target in 12 months and stocks fall 15%, you are not indifferent. You are probably concerned.
Retiring in 30 years? You have plenty of time to make up for negative returns from stocks in the near-term so don’t sweat that 15% drop!
Financial media tends to overcomplicate investing with new funds and hot stock tips.
If you commit the time upfront to plan your cash needs and check in on progress over time, either solo or with an advisor, you can build portfolios designed to maximize your return for risk taken for each cash need in the future.
