13 Apr 2012 The Tortoise and the Hare

Today’s Brief explores our natural affinity toward pizazz and speed as we select our  investment options. We intuitively know that slow and steady will get the job done, but the faster ‘get rich quick’ options always seem so attractive.

Back in 560 BC or so a fellow named Aesop effectively portrayed our penchant for speed in his fable The Tortoise and the Hare. You know the story; the arrogant hare, while ridiculing the tortoise, was challenged to a race. After quickly leaving his challenger in the dust, the over-confident hare tires and decides to take a nap, only to find later that he has been passed by the steadily plodding tortoise.

But, even knowing the story, who would really bet on a tortoise in a race against a hare, except maybe Aesop or the tortoise? It just doesn’t make any sense. We seem to be naturally drawn to the speed and confidence of the hare. In the same way, in our investing, we are attracted to the hottest mutual funds and stocks. They are so much more appealing than plodding, boring index funds.

So let’s have a little race ourselves. If you could go back to 2000 and pick just one stock, knowing what you know right now, which one would it be? I’m guessing Apple would be top-of-mind for many. Since the beginning of 2000 Apple has generated a cumulative return of 2,232% or 29.3% annually. A sum of $100,000 invested in Apple on the last day of 1999 would be worth $2.3 million today.

Now let’s make this race really interesting. What if you were 65, ready to retire, and that you could go back to January of 2000, with perfect knowledge of how two investment choices would perform? You have $1 million and want to spend at least $80,000 of it annually. Your choice consists of a dull index portfolio consisting of 60% stocks and 40% bonds and cash or Apple. You are told that the 60/40 portfolio will earn 4.9% annually while recalling that Apple will return 29.3%. annually for the next 12 years. Which one will you choose?

If you succumbed to temptation and picked the Apple, I’ve got some bad news for you: in mid-July of 2007 you would receive a phone call from your advisor informing you that your account was fully depleted.

Alternatively, if you opted for the ‘tortoise’ portfolio, of 60% stock and 40% bonds, you would have plodded comfortably along, through 2007, 2008, 2009, 2010, 2011, and 2012. As of March 31^st of this year, you would still have $197,308.

Data Source: Morningstar

As you look at the data above, the first thing that might surprise you is just how badly Apple got hit in 2000. Just a moment ago, when you were making your selection, you likely remembered 2000 was a tough time for tech stocks, but that stellar12-year return you heard about, likely helped persuade you to set 2000 aside as an ugly and horrible outlier. But as you look at the numbers more closely, see what a cost to lifestyle that‘ugly outlier’ inflicted. Your portfolio fell from $1,000,000 in 2000 to $266,430 in just a year.

Back to our metaphor: What a costly nap it was for our hare! But maybe all would not be lost. The following year’s 64% sprint might just get him back in the race, but alas, another rest stop of 31.2% would be required. Unfortunately from there, the race was over. Our hare ugh, Apple would never catch up, even with its blistering hops of 45%, 183%, 157%, and 25% in the years that followed.

The birds-eye view of the race shows that it was never really close.