Despite all of the bad news, we have been getting wealthier, as a nation. Last week, the Federal Reserve posted figures on the total net worth of all Americans (the value of our assets minus our liabilities).
Americans have overcome the disastrous devaluation our net worth that occurred in 2008. According to the Federal Reserve the total net worth of all American households is 20% higher than it was at the beginning of 2008, totaling 81 and a half trillion dollars.
Most of the gain is due to rising stock prices. The total value of all the stocks we own has gone up almost 40% since January 2008 to 21 trillion dollars. Yet, despite the fact that it has yet to recover to pre-2008 levels, real estate is still American’s most heavily owned asset at almost 23 trillion. We also have almost 10 billion in our bank accounts and just $3.5 trillion in bonds.
The vast majority of the real estate we own are the homes in which we live. A large percentage of the money we have in banks is for shorter-term needs. So, let’s examine the country’s aggregate investment portfolio; the stock and bonds we own.
Together, we have about $25 trillion on stocks and bonds (interesting fact: over 10% of that is invested through Vanguard). However, if we look at that $25 trillion as a single portfolio, we are dangerously overweighted toward stocks. We have over 80% of our total national portfolio in equity securities, with just under 20% in bonds.
On an individual basis, there are very few American’s who could comfortably own a portfolio with only 20% in bonds. This is because an 80/20, well-diversified stock to bond allocation would have meant a single year decline of more than 40% since 1970.
If this was your $1 million retirement portfolio and it lost $400,000 in a single, you would probably panic and decide to sell to cut your losses. That’s just the kind of behavior that led so many to leave the market late in 2008. Many of those have yet to get back into stocks despite their meteoric rise over the past 5+ years.
These figures show that, as a nation, we are still allowing greed to blind us to the potential volatility (you notice, I purposefully used the word volatility instead of risk – risk implies a chance of total loss that, realistically, doesn’t exist in a well-diversified portfolio) of our investment portfolios. This is why we get caught up in a boom/bust mentality that creates a climate of fear.
Rather than running with the herd, manage your portfolio with your personal, psychological tolerance for risk (volatility) the top priority. Over the past 44 years, you would have been better off accepting the 8% average annual return from a portfolio that was 20% in stocks and 80% in bonds (that suffered a less than 10% one year loss), than stretching for the potential 12% annual return of the 80% stock/20% bond portfolio that would have likely cause you to panic and sell (thus eliminating any chance at the 12% per year) when the portfolio declined 40%.
Every investor needs a well-diversified portfolio built around their personal risk tolerance to save them from dangerous emotional decisions.