December 22, 2020
Mark Minchin

Mind Your Negativity going into 2021

Some sentiments doing the rounds right now:

  • The 4% rule (consuming 4% of your portfolio value each year) will never work anymore because bond yields are so low.
  • Tech stocks are going to see a spectacular crash.
  • The stock market is running on borrowed time. Valuations can’t go up forever.
  • The real estate market is being propped up by low interest rates. Just wait until they rise.
  • The only reason markets are up is because governments have thrown trillions of dollars at their economies. This can’t last.
  • The global debt bubble is going to lead to the biggest crash in history.

It is understandable that people are negative. 2020 has not been a walk in the park. There has been plenty to worry about.

For investors, it is true that cash and bond yields are extremely low. The 90-day bank bill rate in Australia is currently at around 0.05% and the yield to maturity on the global bond market index – the Barclays Global Aggregate – is currently 2.16%. These two things in concert mean that a significant portion of a diversified portfolio is going to produce a very modest return in the near term.

Whatever way we cut this, there really are no easy answers. For most of us, having all our money in riskier, higher returning assets like shares and property is not a prudent option.

This and other dilemmas have encouraged investors to explore non-traditional alternatives: buy gold, buy bitcoin, chase technology stocks, or bury your money in the back yard. But most of these strategies become flimsy when you carefully consider the fundamentals. Often, they are more akin to conspiracy theories than proper investment strategies.

Relying on forecasts to tell us where to put our money is seductive, yet it too does not stand up under scrutiny. The overwhelming evidence from decades of academic research is that nobody can reliably and accurately forecast what markets will do next.

Consider a few details of the track record of stock market forecasters over the last year, as compiled by Bloomberg.

In December 2019, the median consensus on Wall Street was that the S&P 500 would rise 2.7% in the 2020 calendar year. Right now, that target is too low: On Friday, the US stock market was up almost 15% for the year (!). That is a forecasting error of more than 12% — much greater than the estimate of the market’s increase for the entire year.

Then in April, the Bloomberg survey showed, forecasters predicted that the S&P 500 would not rise at all for this calendar year: They said the market would fall about 11%. But the market had begun climbing on March 23, the day the Fed intervened to stem panic. The strategists failed to register the change in direction. On Friday, that “corrected” consensus forecast was off by a whopping 26%.

In times like these it is instructive to look for where real long-term returns have come from. And looking through the decades the enduring sources of investor return have come from one of three places:

  1. Rental return from owning real estate,
  2. profits & dividends from owing businesses, and
  3. interest income from owning debt.

As water finds its way down hill to the deepest reservoirs, so too capitalism allocates money to the investments that offer the most alluring returns. And so, these three key pillars of capitalism – property, shares and debt markets continue to provide sustainable long-term returns.

The most successful investors have captured these returns in their purest form, minimizing the involvement of ‘middlemen’ and financial engineers.

Despite the tough choices we face today, ultimately, we still need to invest. And time and time again the traditional approach of carefully blending property, shares, bonds and cash in a manner that suits our individual risk/return needs, outperforms expectation and smooths out our returns.

Those who stayed disciplined with their investment strategies through the lows of March and April this year have been well rewarded. Since that time, in just eight months, an average 60/40 balanced investor portfolio has defied the pundits, returning around +18% and putting the strategy comfortably into ‘the black’ on a rolling 12-month basis. Not a bad result for a year that has seen what it has seen.

And staying disciplined wasn’t easy. It is worth remembering the headlines and conversations that were taking place back then:

  • The end of free markets.
  • Governments to socialize industries.
  • Global depression mark II.
  • The worst is yet to come.
  • Billionaire investor says to remain cautious.
  • Vaccines years away, if at all.

Optimism is a powerful motivator, but during stressful times it can be trumped by pessimism and fear. Studies in the field of behavioral finance have suggested that the pain of losing is psychologically about twice as powerful as the pleasure of gaining. This way of thinking pervades us all, and as such it is worth being mindful of our own biases. The biggest mistake investors have made over the long run is being insufficiently optimistic about the future. Remember that stock markets rise more than 70% of the time. There may be some ugly periods ahead of us, but over the long run it should be ok.

Having a long-term strategy that you can stick with is the key, and in the absence of any significant change in your life circumstances, it is most likely that you will be best served by sticking with your current strategy.

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