By: Dividend Sensei
Because Calpers made the same mistake that millions of investors make. They tried to time the market. For example late in the financial crash Calpers was busy selling stocks. They invested a lot into hedge funds, which do best in a downturn because of hedging through things like selling stocks short, and protective use of options.
When the bull market started these high priced funds, (which usually charge 2% of assets and 20% of profits), badly underperformed. The good news is that Calpers did eventually get back into the market in a big way. The bad news? It wasn’t until 2017 when the pension fund achieved 50% equity exposure. In other words Calpers sold at the wrong time, when stocks were at fire sale prices, on the assumption that stocks would fall far more than they usually do in a bear market. They then refused to exit their hedged positions until it was far too late, only taking an aggressive position in stocks after valuations had become highly inflated.
Here’s what Calpers, most endowments, and most investors would be far better off doing. Keep 4 years of cash on hand, for expenses and liabilities (like pension payments or retirement costs). Keep the rest in a low cost index fund such as SCHD. Then ignore market fluctuations, and NEVER panic sell into a downturn.
Note that 94% of rolling 10 year market returns are positive. And never in history, not even during the Great Depression, when stocks fell 90% peak to trough, has the market failed to generate a positive return over a 20 year period. The bottom line is that volatility isn’t just normal, it’s good. That’s because if stocks only ever went up in a straight line and at a steady pace then there would be no equity risk premium. In other words if markets only ever went up, then the amount of profits you could make would be miniscule.
The very reason that stocks are the greatest wealth creation engine of all time is precisely because markets are irrational in the short-term, and fueled by great swings in emotions. They can easily become overly pessimistic, or overly optimistic. That’s what creates the opportunity for rational, calm, and educated investors, (students of market history), to not just get rich, but also beat the market over time.