We are almost in the mid year. It’s time to reflect ahead of the second half of the year and think of the future regarding investing and retirement planning.
When we reflect and look at our nest eggs we should have seen very good returns. We may have become overconfident and think that either “I am smarter than the rest” or “I made a killing in the markets,” or perhaps why did I listen to that advisor and invest in a product with lower returns when the stock markets are where the action is.
Investors are often driven by performance and the potential of large returns. So why would investors consider an asset allocation model with 8% returns when they achieve growth of 15% or more on the markets?
For those unfamiliar with the concept, asset allocation is an investment strategy that aims to reduce volatility, balance risk and reward by creating a diversified portfolio of different investments or asset classes that have little or no correlation to each other as they have different levels of risk and return, and will behave differently over time.
One should always review the performance of the previous year and while fees and asset allocation do affect portfolios, we should also be aware that people suffer from what behavioural science calls “recency bias” i.e. we look at the past and assume the same thing will continue into the future.
The result is that many investors fall into complacency. Looking back at the last several years many people will look at this lack of volatility and see fantastic performance.
The American markets are not cheap, other
markets are much cheaper. The UK is very cheap just now and we have a lot of potential in Europe and the Far East.
If the good new keeps coming, the markets can still go up substantially and for a long time.
However, just as every night is followed by day, every Bull Market, where share prices go up, is followed by a Bear Market, where share prices go down.
Hence, we should look at what we can learn from similar situations in the past.
Back in the late 90’s when internet stocks were flying high, companies could stick a .com on to their name and their shares went flying (sounds similar to the companies changing to blockchain such as Kodakcoin, Long Island Iced Tea to Long Blockchain Corp, you can’t really make this sort of thing up). Many of these companies had low or zero earnings or even sales yet they went through the roof. But then a correction followed, from peak to trough the loss was about 96% over a 2 ½ year period.
Complacency raised its ugly head again after the financial crisis, the market collapsed, and we were all convinced that a weak economy and weak stock markets were the new normal. What happened was that we then went into one of the greatest bull markets in history, with a return of 268% (dividends reinvested).
Complacency once again, stocks have been the best performance asset class of the last 9 years, so why should we consider asset allocation models?
We have no idea when this run of performance will be shattered, but at some stage it will.
Insurance companies, Sovereign Wealth Funds, Family Offices, Endowments etc, never do 100% stocks, they know about volatility and different returns for different asset classes. What do they know that we don’t?
When you listen to financial experts, they talk about cycles and show impressive charts that show the start and end of various asset class cycles. The problem with this approach is that it is all done with hindsight, looking back at charts and finding a random pattern. It is a bit like art connoisseurs looking at a picture and having different interpretations. Those experts then write articles like this one just to make an interesting story.
However, when living in the present it is extremely difficult to predict when new cycles start and old ones end. If we could, we would all be billionaires. In 2000 we hit the high on stocks, in 2008 we hit the high in energy and base metals. Perhaps in December we will hit the high on Cryptocurrencies but we won’t know til later. For US stocks we are late in the cycle and interest rates appears to be the at the end of the current cycle. Gold may be in the start of a new cycle, especially if the Bitcoin bubble bursts.
What I am trying to say is that people have recency bias. Cycles come, and cycles go. So be wary with the stock market, especially in time of strong growth and diversify into different asset classes because, as mentioned before, after every Bull market comes a Bear Market, and after every rise comes a fall.