Four investors walk into a bar … Part 2

In part one of the series the bar going investors learned the following crucial lessons:

Investing for the long term and staying the course is a key tenet to achieving wealth generation objectives.
The compounding effects over long periods of time can be phenomenal.
The possibility of negative returns diminish as the time horizon gets longer.
Historically, Mr. Market has proved to deliver positive returns over long periods of time, despite his unpredictable temperament on any day—companies invest for growth and require time to deliver value to shareholders. Successful companies generally become larger over time, and the ones that fail are taken out of the market.

“People who invest make money for themselves; people who speculate make money for their brokers.” Benjamin Graham, The Intelligent Investor

Back to the bar in 1992, with Annie, Bridget, Charlie, Don, and Mr. Market.
It's December 1992, and armed with these insights, the four investors wanted to understand from Mr. Market how to time the market better. They wanted to understand what they could do in terms of their buying and selling decisions through time that would produce better results.

Mr. Market’s intriguing proposition to the four investors.

Mr. Market proposed a 30-year competition to the investors. The rules would be simple.
Annie, Bridget, Charlie, Don, and Mr. Market each start on $100,000 as a lump sum.
Everyone has $1,500 per month as an additional discretionary amount to invest into cash or the market.
The investors simply had to choose a rules-based approach, based on their personalities, to buy/sell for the 30 years.
The rules-based strategy is used more for giving the investors some sort of discipline in terms of their actions with the markets. This is similar to well-rated fund managers who apply process-driven approaches consistently.
After 30 years, they would look at their investment balances to see who won.

Assumptions about the future

Remember, these humble investors were not able to make any prognostications about the world and how it would change and take shape. The scenarios and settings for the future were too open.

They didn’t have mobile devices by which they could monitor the market like today’s high-frequency traders. They opened the physical newspaper daily to look at stock performances, watched the news, and stood by their fax machines, which were in vogue.

They could not imagine the scale of China’s growth into prominence, though Paul Keating’s 1993 Australia Day address would show awareness of Australia’s economy being dependent on Asia.

The flow of information and the world were a lot slower. Intel had just launched the Pentium processors, Bill Clinton was president of the USA, and the European Union was being formed.

So, who is the winner?

The winner of the competition was Mr. Market (aka the Vanguard Australian Share Index Fund). None of the investors were able to beat the S&P/ASX 200 Index or Mr. Market. Vanguard was shown as it’s the closest proxy for Mr. Market after fees for the everyday investor.

Naturally, the Vanguard fund would always lag the index because of the fee layer and a small cash drag accumulating over time.

It is also noted that some of the fee layers in funds management have closed significantly compared with what they were in 1993. According to Morningstar's data, the fee for the Vanguard Australian Shares Index fund was 0.33% per year in 1998, and it has dropped to 0.16% per year currently.

Annie was very close in second place, followed by Charlie and then Bridget. They were all within $45,000 of the Vanguard balance after 30 years.

Don was the investor who had the lowest investment balance after 30 years.

So, why couldn't the investors outperform the Vanguard fund (aka Mr. Market after fees)?
Remember, the four investors had their own triggers and actions that were repeated in the market over the course of 30 years.

The only element of cash flows that were moving in or out of the market was their $1,500 investment monthly. The $100,000 lump sum can be thought of as the initial saving, while the $1,500 monthly investment was their monthly saving from a salary or elsewhere. The $1,500 per month was not enough to "move the needle" in the overall portfolio when taking advantage of market declines.
The simple reason for all of the investors not being able to beat the Vanguard fund (aka Mr. Market after fees) was that, while they were accruing cash to take advantage of a selloff, Mr. Market was always fully invested. Their returns were being diluted over time, even if marginally, because of being out of the market.
Annie, Bridget, and Charlie did fairly well with their strategies of buying when the market fell but were still fell short of Mr. Market at the end of the 30 years. Their cash balances accrued while they waited for their respective triggers to buy into the market. In that time, the market was still compounding upward.
Don was the extreme example of the nervous investor. Every time the market fell, he sold his position downward for fear of further declines. And he was unable to buy back into the market.

A key question is: Which investor are you?

What is your strategy toward the market?
Are you proactive or reactive?
What were your actions in your portfolio during market selloffs or high points?

But wait, there's one more thing…

How would an investor have done over the 30 years if they were fortunate enough to have invested the total capital of $643,000 as a lump sum?

Key takeaways

The key and clear conclusion from this is that time in the market matters more than timing the market. The compounding results over 30 years were phenomenal. We have no certainty of a repeat of the previous 30 years' performance over the next 30 years, though to paraphrase an unknown author of a famous quote, "It does often rhyme."
Most people do not have the ability to invest significant lump sums initially, so most investors are dollar-cost averaging when they have a monthly investment.
Any additional windfalls along the way should be viewed as a lump sum that can be added in to have a longer time in the market.
It is exceptionally important for investors with mindsets toward the markets to note the significant implications of these results.