Lessons from the last year
As an investor one is always learning. Our perception of investing is guided by our experiences: those old enough to have been investing in the 1970s will retain uncomfortable memories of rampant inflation and the impact that had on cash, bonds, and the general travails of life when prices spiral upwards.
Others who lived through the birth of the internet and the boom and subsequent bust of the ‘dot.com’ era of the late 1990s and early 2000s, may also be living through a sense of déjà vu.
For most investors, interest rates have been on a steady long-term decline making mortgages cheaper and supporting bond and equity prices. In the past twelve months, we have been reminded of some useful lessons that can – hopefully – make us all better investors. Several key lessons stand out for us:
Markets go down as well as up. In the decade following the Global Financial Crisis, investors were treated to a long and almost interrupted run of rising equity, bond, and property markets. It seemed as if everything always went up. The first quarter of 2020 reminded us that this is not always the case. Some equity markets fell in excess of one third of their value. It could have been much worse. A useful rule of thumb is that the equity content of a portfolio could easily fall by 50%, as it has in the past on several occasions. Equity investors get rewarded for taking on this uncertainty and pain, eventually.
Short-term pain does not become long-term pain unless you sell. Those who needs their money in under a year should not own any equities at all. In reality, most investors have very long-term horizons; after all, if you are 60 you should be planning to be invested for at least another 40 years! Yet it is a sad fact that some investors panic and sell out when markets nosedive, even though they don’t need their money that year or probably for many years. Broad global markets have recouped all of their losses (and more) since the start of 2020 to the start of March 2021. Bailing out of a long-term strategy can be costly. Most investors who need to withdraw money from their portfolios own high quality bonds that they can sell to meet expenses, leaving their equities intact.
High yielding bonds have equity-like characteristics. During painful sell offs, investors need to be able to rely on their bonds to help ease the pain. Unfortunately, high-quality bonds (i.e. bonds from the most credit-worthy issuers) pay low yields. Yet, high yielding bonds – from lower quality corporate and emerging market borrowers – are not the solution as they act far more like equities, just when you do not want them to. Sticking with high quality bonds is an insurance policy. Owning the right level of insurance coverage is important.
Fads, trends, and social media tips are dangerous to your wealth. In the past few months, we have seen extraordinary share price rises of many growth-oriented companies, particularly in the US. For example, Tesla’s stock price rose from US$121 a year ago to a high of $883 on 25th January 2021. Social media pumping of stocks like GameStop and the ‘enthusiasm’ of online retail investors pushed some stocks ‘to the moon’🚀🌙 (symbols used on social media to signify a ‘great’ stock!). Yet most turned out – or will turn out - to be meteorites falling back to earth. Tesla’s stock price has fallen by around a third since then. Owning stocks is for the long run. Owning them for short-term gains is gambling with costly consequences for most. Let others take the losses. Remember that owning a diversified portfolio means that you already own many of tomorrow’s winners. Be happy with that.
Inflation may not be dead. We have been living for some time in a relatively benign inflation environment. Yet, the huge levels of government stimulus and consequent growth of the money supply – not least the US$1.9 trillion (i.e. $1,900,000,000,000) package in the US – risks fanning inflation. Inflation is a form of unlegislated, invidious taxation.
Bonds do not always go up. Inflation – or the fear of inflation - is bad for bonds. Bond yields - that incorporate the market’s view on future inflation - have risen of late as a consequence, pushing bond prices down. Bond yields have been falling for around 40 years to historic lows, so this is new to many investors. Owning shorter-dated bonds helps lessen the pain and investors benefit more quickly from the rise in yields.
Gold is not a good short-term hedge of inflation. Although the salaries of comparably ranked army officers from Roman times to today – a mere 2,000 years - are almost identical in gold terms (1) (i.e. the price of gold has kept up with inflation), just as we are potentially experiencing a rise in inflation, gold prices have been slumping from above GBP2,050 per ounce in August 2020 to below GBP1,700 per ounce today. In fact, gold’s inflation-busting myth relates to the 1970s when inflation was rampant and gold prices rose dramatically. Correlation does not imply causation.
It is always darkest before dawn. The last 12-month period has seen some tough times for everyone, both in terms of our personal lives and in the markets. It is always easy to see the doom and gloom, but there is light at the end of the tunnel. Keep positive. This too, shall pass.
These lessons lead us to some obvious conclusions about portfolios. Own a sensible balance between bonds and equities and understand that owning high-quality bonds is an expensive, but necessary insurance policy for most and allows you to meet your nearer-term liabilities.
Own a globally diversified equity portfolio. A few US technology stocks cannot continue to out-run markets for ever. Keep the faith in your long-term portfolio strategy and turn your eyes away from market temptations!
At the end of the day, building wealth from investing is a long, boring process interspersed with years like the one we have just had. We survived what the markets threw at us and will survive whatever comes our way again. Stick with it.
(1) Erb, Claude B. and Harvey, Campbell R., The Golden Dilemma (May 4, 2013). Available at SSRN: http://ssrn.com/abstract=2078535 or http://dx.doi.org/10.2139/ssrn.2078535.
Risk warnings
This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
Past performance is not indicative of future results and no representation is made that the stated results will be replicated.