A benefit of the Apollo missions was the phrase, "If we can put a man on the moon, surely we can...". It offered optimism that we can solve almost any complex problem.
So, if we can put a man on the moon, surely we can improve financial education enough to convince all investors to stop making poorly timed, ill-informed, overpriced and emotionally driven investment decisions.
Right?
Wrong.
It will never, ever happen - as a group, at least.
There is an unbreakable rule of financial markets that is as important as it is depressing: Some people must have a miserable experience. No amount of technology or education will ever change this. One hundred years from now, there will be as many stories of investors shooting themselves in the foot as there are today, and as there were 100 years ago.
Two points, neither of which are controversial, show why this is.
The first is that stocks are a volatile mess, and they always will be. They have to be.
If there were no booms and busts, no bear markets or wild bubbles, no unexplained 10 percent sell-offs, and stocks casually drifted upward year after year, something inevitable would happen: Everyone would put all their money into stocks. Why wouldn't you?
If there's no downside and stocks offer higher returns than cash or bonds, you'd be crazy to not put every cent to your name in stocks, plus mortgage your house to add more. As soon as that happened, prices would rise and stocks would get extremely expensive. And soon after they get expensive, history shows, volatility isn't too far behind, as an inevitable bout of bad news strikes and reality slams into expectations.
The paradox is that as soon as you promise no volatility in the stock market - or when people start believing that to be the case - the fuse of future volatility is lit. A prolonged period of no crashes increases the odds of a future crash. That's why markets will always be volatile.
The second point is understanding what volatility is. Pundits often say "people sell stocks when they're low." But it's actually the other way around. Stocks become low because people sell them. The specific reason there's market volatility is that some people get scared out of stocks, selling them and driving down prices.
So, volatility is guaranteed as a fundamental part of how markets work. And volatility is just a representation of people having a bad experience in stocks. That's why the pain, the suffering, the disappointment and poor behavior will never go away. It can't. People will be losing money in stocks 10, 20, 50 and 100 years from now.
Two things happen when you accept this reality.
One is that volatility takes on a new meaning. Every downturn comes with two reactions: "I'm surprised this is happening," and "Why is this happening?" Accepting the reality of volatility answers both questions. No one should be surprised when the market drops, because if it never dropped it would get so expensive that no one would be interested in it anymore, which would make it drop. And the answer to "Why is this happening?" is blindingly simple. It's happening because, at every point in time, someone's patience is tested enough to be one of those people no longer interested in stocks. It has always been, and always will be, this way.
The second is a guide toward improvement. Some people must get scared out of stocks, and the surest way to improve your odds of success is moving mountains to not be one of them. This includes: having enough liquid cash to make it through inevitable periods of disappointment; having a working knowledge of the frequency of market declines; goals at least 5-10 years in the future; and an almost pathological inability to care what the market does in the short run. The good news is doing this becomes easier when you accept the reality of volatility.
The Upside of Losing Half Your Money
Investment firm Horizon Research Group wrote a paper a few years ago about a group of art dealers (and their relatives) who made fortunes in the 19th and 20th centuries. A small handful of dealers ended up owning massive collections of masterworks by Picasso, Matisse and Klee worth hundreds of millions of dollars.
What's incredible is that the value of art is subjective. It's impossible to know what a new piece of art will be worth 100 years from now since value is driven by taste. Some of these dealers were buying paintings that hadn't even been produced yet - they didn't know what the art would look like, let alone what particular artist would be admired decades down the road. But they ended up making fortunes on them.
"How were they able to choose so wisely?" the researchers asked.
It wasn't just luck, because the handful of dealers all did the same thing.
"The great investors bought vast quantities of art," Horizon wrote.
The dealers traveled around buying as much art as they possibly could from as many artists as they could find. Literally thousands and thousands of paintings. They diversified. "A subset of the collections turned out to be great investments, and they were held for a sufficiently long period of time to allow the portfolio return to converge upon the return of the best elements in the portfolio."
They basically owned an index and sat back, knowing most of the paintings would be duds but a few would explode.
Which is exactly how investing works.
One of the most amazing investing studies I've seen is a JPMorgan paper showing the percentage of Russell 3000 companies that suffered "catastrophic loss" from 1980 to 2014. A catastrophic loss is when a stock falls 70 percent or more and never recovers.
The Russell 3000 increased 49-fold from 1980 to 2014. But, amazingly, 40 percent of companies in the index had catastrophic losses. No industry was spared.
JPMorgan's data shows 64 percent of stocks underperformed the overall index from 1980 to 2014. About a third were reasonable winners, and 7 percent of components absolutely knocked it out of the park. The return of those 7 percent was enough to not only offset the losers but push the entire index up almost 50-fold.
This is no different than what the art dealers accomplished.
The key to making a lot of money is to own so much stuff that you guarantee capitalism will destroy most of your investments, but equally ensure that a tiny group of successes will offset those losses. Over time, the overall return converges on the best elements of the portfolio.
The benefits of diversification are well-known. But I wonder how many index fund owners realize half their hard-earned money is going up in flames - by design.
My guess is, not many. Which is a reminder that we should focus on how our whole portfolios are performing over any individual component, and be more sympathetic when reading news about another company going up in flames. They are, after all, the norm.