A stoic acceptance of “the brutal facts of reality” and “an unwavering faith in the endgame.” That’s how Jim Collins, author of Good to Great, describes The Stockdale Paradox, which is named for Admiral Jim Stockdale, the highest ranking U.S. military officer to be held captive in the infamous “Hanoi Hilton” during the Vietnam War. The lessons of how he survived, and why many others did not, are directly applicable to investors.
Faith grounded in reality
As Stockdale reflected on the eight brutal years that he was held as a prisoner of war, he attributed his survival, in part, to an unwavering belief that he would one day be released.
“I never lost faith in the end of the story,” he told Collins. “I never doubted not only that I would get out, but also that I would prevail in the end and turn the experience into the defining event of my life, which, in retrospect, I would not trade.”
At the same time, his firm belief that he would survive, despite being tortured over 20 times, was grounded in the reality that it may take a long time. Asked who did not survive, Stockdale said, “Oh, that’s easy. The optimists…They were the ones who said, ‘We’re going to be out by Christmas.’ And Christmas would come, and Christmas would go. Then they’d say, ‘We’re going to be out by Easter.’ And Easter would come, and Easter would go. And then Thanksgiving, and then it would be Christmas again. And they died of a broken heart.
"This is a very important lesson. You must never confuse faith that you will prevail in the end—which you can never afford to lose—with the discipline to confront the most brutal facts of your current reality, whatever they might be."
What does this have to do with investing? Quite a bit, actually.
Wildly optimistic
The Stockdale Paradox came to mind when I read the results of a recent survey of 750 U.S. investors conducted by Natixis Investment Managers. It found that investors are expecting to generate a whopping 15.6% average annual return above inflation. The survey noted that’s 123% higher than what financial advisors see as realistic.
Where did investors get such unrealistic expectations? Dave Goodsell, head of the Natixis Center for Investor Insights, said it’s a lingering effect of the last lengthy bull market. “In the decade between 2012 and 2021, even the least experienced investors looked smart in a market that delivered high returns with low risk and relatively little effort.”
Optimism that isn’t grounded in reality won’t put investors’ lives on the line, as it did for many American prisoners during the Vietnam War, but it’s likely to leave them ill-prepared for retirement. “Fear and flawed assumptions are a combustible combination that can lead to irrational behavior and costly mistakes,” Goodsell said.
Where it matters most
At SMI, we believe all investors should have a plan that contains answers to key questions. When do you plan to retire? How much money will you need in an investment account at that point? What’s your risk tolerance? What investment strategy or strategies are you following and why? What average annual return are you counting on? What will you do if your investments do not perform as expected?
All of this may change over time, which is why we recommend seeing your investment planning not as a one-and-done sort of exercise, but as something to revisit regularly. The Stockdale Paradox is especially applicable to two assumptions in your investment plan: when you plan to retire and the average annual return you expect your investments to generate.
While more and more people are planning to retire later than the traditional retirement age of 65, most still actually retire at that age or even earlier. In many cases, that’s because of personal health issues, the health issues of a loved one, or a company downsizing. So, it would be wise to envision your ideal retirement date and then base your plan on a retirement date a couple of years earlier.
As for an assumed average annual return, the numbers in a retirement planning calculator sure look better when you use the stock market’s long-term average annual return of about 11%. However, the reality is that the market’s annual return is rarely 11%. One year, it’s 25%. Another year, it’s -30%. And then it’s 2%, and then 8%, and then -14%. Market returns are far from smooth; they’re lumpy. So, it would be better to set your average annual return assumption at a lower-then-hoped-for number and be happily surprised when you exceed it rather than the other way around.
Managing your expectations regarding your retirement date and average annual return will lead to a higher monthly contribution amount than you may prefer, but that’s something you have far more control over.
Accepting “the brutal facts of reality” while at the same time maintaining “an unwavering faith in the endgame.” How well are you incorporating The Stockdale Paradox into your plans?
