Taking part in market gains can be more lucrative than beating the market over time

Investing and financial planning often present counter-intuitive realities.

Many people, trying to build security for retirement and then maintain that security through retirement, try to pick investments that will outperform returns available from simply holding index funds representing the broad market of stocks or bonds.

But the performance of their investments compared to broader market returns might matter far less than the prevailing market conditions through different cycles over time.

It’s possible that you could have wildly successful performance relative to a benchmark such as the S&P 500 Index of large U.S. stocks for a whole market cycle but build far less wealth than if you underperform the S&P 500 by an equal amount during a more robust cycle of returns.

Nick Maggiulli, blogger at Of Dollars and Data, recently noted that if you outperformed the S&P 500 by 5 percent per year from 1960 through 1979 — a feat used only to make a point, nobody achieved this — and then underperformed the index by 5 percent per year from 1980 through 1999, you would have been made far more financially secure from the period of underperformance because the returns available in the market were so much stronger than the 1960-79 period.

The same results apply to more recent investment cycles.

You could have generated returns far better than the S&P 500 from 2000 through 2009 but far worse than the S&P 500 since then and been far better off with a performance that was worse relative to what a passive investor earned from not trying to beat the market.

If you started with $10,000 on Jan. 1, 2000, and beat the S&P 500 by 5 percent per year through the end of 2009, you would have ended with $15,027.83 based on compounding annual total return (price appreciation plus dividends). Start with $10,000 Jan. 1, 2010, and underperform the S&P 500 by 5 percent per year and you would have had $19,584 at the end of 2017.

Of course, if you had simply been an index investor with the fortitude to stay invested through bear markets of 2000-01 and 2008, you would have been better off yet, turning the original $10,000 in 2000 into $25,524 through 2017.

The challenge is that few people are content with declining markets or underperforming returns regardless of the broader context of their financial security.

Money comes with emotion — fear and greed are at the root of investing psychology and there is a role for ego in investment decisions as well. While the 1980-99 and 2010-to-current periods generated substantial wealth creation, most people would have felt less good about it if they underperformed what was potentially available.

In fact, while their investments were underperforming, they would likely have been irritated enough to move their money around trying to catch up, increasing transaction costs and chasing performance after it had been recorded.

Whether making investment decisions at market highs, lows or somewhere in between, you are always faced with uncertain outcomes and incomplete information about true value of the current market, economic direction and psychology of investors that collectively make up the marketplace.

Future returns will likely be both dramatically in your favor and not at different times. To capture the good, you have to start investing early and stay invested through challenging times. The cycle of the market will largely influence your portfolio performance.

Whether the most recent cycle for U.S. stocks topped out on Jan. 26 or is just experiencing a temporary lull on the way to yet newer all-time highs is hard to say.

The unknown of when returns will materialize and the uncertainty of the range of outcomes that will apply to your personal experience make investing difficult. To best address difficult unknowns, core tenets of successful investing can be kept simple:

▪ Establish a savings rate commensurate with your future spending needs beyond Social Security and other retirement income sources.

▪ Understand your natural inclination to be conservative or aggressive and diversify your investments within the context of either.

▪ Rebalance to a targeted weight of stocks periodically to keep the risk/return profile of your portfolio aligned with your goals and comfort level with market fluctuations.

▪ Be tax efficient. You can spend only your after-tax returns.

Decision-making amid swings in markets, economic conditions and personal life transitions along the way is complicated. To be better prepared and help overcome inertia, make sure you have a strong understanding of how your money is working for you and what you need to do over time to increase the probability that your financial plan will have staying power.

Conviction for your money-management process should ultimately prove more lucrative than whether your investments outperform or underperform from year to year.