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Why traditional investment strategies don’t work

  • Traditional aggressive growth strategies no longer work, because they fail to take into account extreme volatility and the increasing frequency of bear markets.
  • Nearly 50 percent of the sales of S&P 500 companies originate outside the U.S — that's good for growth opportunities but exposes investors to more volatility.
  • In today's low-interest-rate environment, investors will be lucky to keep up with the rate of inflation.
Traditional aggressive growth strategies no longer work because they fail to take into account extreme volatility and the increasing frequency of bear markets.
Camerique/ClassicStock | Getty Images
Traditional aggressive growth strategies no longer work because they fail to take into account extreme volatility and the increasing frequency of bear markets.

Traditional investment strategies no longer work, and no single factor explains the failure of long-held investment tactics. Market volatility, global economic interdependence, emotional investing, inflation and a low-interest-rate environment all played a role in the demise of traditional investment strategies.

Let's take a closer look at each factor individually to better understand why the old methodology comes up short in this new market reality.

Market volatility

There's no way to sugarcoat it — market volatility is the new normal in today's investing environment. For decades millions of American investors have followed an aggressive growth strategy — a strategy that worked. For many it went like this: During those wealth accumulation years, invest heavily in equities such as blue-chip stocks. Rinse. Repeat. And for decades, as long as investors kept a long-term view, that formula worked.

Sure, there were bear markets to contend with (1966 to 1978 is one example), but they were bolstered by a more glacial pace. The markets moved with a more predictable upward or downward momentum, a fact no longer true in today's violent market swings. Those traditional aggressive growth strategies no longer work, because they fail to take into account extreme volatility and the increasing frequency of bear markets that leave investors, especially those closer to retirement, exposed.

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Consider for a moment a typical American investor, age 60. We'll call him Dave. During his career, Dave worked and saved, but he's now thinking about retirement. After all, he's built a nest egg of a little more than $470,000, and he's getting close to his goal of retiring with $500,000 socked away. Even though Dave has already diversified and downshifted into a more conservative blend of equities and bonds, he could still hit his $500,000 target within a year with his projected growth of 8 percent returns.

But as with millions of American investors, Dave's success is closely tied to market timing. What if Dave's last year of work, that last year of looking to take a somewhat aggressive approach, occurred in 2000 or 2008? In that scenario, much of Dave's nest egg would be ravaged by bear markets. While those are the two biggest bears of this century, those massive swings are happening with increasing regularity, leaving investors who follow a traditional investment approach vulnerable to market volatility.

Global economic interdependence

In the traditional investment approach, an investor like Dave could put his assets in a mix of stocks, bonds, mutual funds, real estate or commodities. With limited volatility and steady growth, he was better protected than in today's marketplace. But there's another layer of volatility that Dave may not be aware of — the global, interdependent marketplace where the lines are blurred between domestic and international holdings. What were once distinct and separate holdings have become closely intertwined.

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At increasing levels, global interdependence has crept into almost every facet of a company's operations, including global sales, international sources of raw materials or services and offshore outsourcing, among others. In today's marketplace, nearly 50 percent of the sales of S&P 500 companies originate in countries outside of the United States, according to data compiled by S&P Dow Jones Indices. While that number is good for growth opportunities, it also exposes investors to more volatility.

Inflation and interest rates

According to the U.S. Bureau of Labor Statistics, the U.S. inflation rate stood at 1.6 percent year-on-year in June 2017. Historically, that's a drop for American consumers, as the inflation rate averaged 3.28 percent from 1914 until 2017. While the rate of inflation has been falling, it remains a cause for concern for investors like Dave, particularly due to the incredibly low-yield environment today's investors face.

If Dave were to get to retirement with his nest egg intact, he might have breathed a sigh of relief in the traditional investment world. He could have shifted much of his equity investments to certificates of deposit and Treasurys, keeping his market exposure low while he reaped a hefty double-digit return. Not so anymore. In the very low interest-rate environment of today, Dave will be lucky to keep up with the rate of inflation. In such a scenario, he might find himself tempted to return to market exposure in the chase for substantial yields.

Emotional investing

Emotional investing is hardwired into our DNA as humans. Dave is not immune to the tug and pull of the irrational behavior that accompanies emotional investing. But make no mistake — human emotions drive bad investment decisions. Picking an occasional winner only gives license to picking more stocks on whims and gut feelings, leading investors to an inevitable bad ending.

"A successful strategy today is one founded on a mechanical model that eliminates the desire for emotional investing, provides a stop-loss mechanism to limit losses and looks for investments across all 11 sectors."

How bad? I mentioned inflation in the previous section, but combined with emotional investing, the result is worse than you might imagine. A report by Dalbar revealed that the average portfolio's earnings have barely kept up with inflation, earning just 3.83 percent from 1992 to 2012. A mechanical model, such as seen with the S&P 500, delivered a 9.14 percent return in that same timeframe.

New models

The traditional buy-and-hold investment models no longer work for investors like Dave. They no longer work for anyone who wants a healthy nest egg by the time they're ready for retirement. In today's volatile marketplace, retirement portfolios require investment strategies that seek growth opportunities while also offering protection against the frequent downsides.

A successful strategy today is one founded on a mechanical model that eliminates the desire for emotional investing, provides a stop-loss mechanism to limit losses and looks for investments across all 11 sectors. In short, it's one that sheds what no longer works and instead seeks reliable returns even amid this highly volatile, globally dependent marketplace.

(Editor's Note: This article originally appeared on Investopedia.com.)

— By Chris Cook, founder and CEO of Beacon Capital Management

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