When it comes to investing, our worst enemy is without question ourselves. Our brains just aren’t hardwired to do it well. We are overconfident, tend to extrapolate the current situation well out into the future, become greedy after prices rise, and fearful after they fall. I almost fell over when I read this Gallup poll about what Americans think are the best long-term investments:
Real Estate? Does anyone bother to look and see how much real estate has gone up in value over the last couple hundred years. On average home prices have only kept pace with inflation according to Robert Shiller (the Yale professor who measures these prices). In addition, there is a major carrying cost associated with real estate (taxes, insurance, repairs, etc). If you want to take a look a little deeper at the data, I wrote about this here. Worst of all, according to Americans the second best long-term investment is gold. Up until a couple years ago, about 2 times as many people thought gold was a better long-term investment than stocks. Again, look at the data. Gold barely keeps up with inflation. Stocks have generated a return approximately 6% over inflation over time. Here is a graphic of how much $1 in different investments grew over a 100 year period:
It’s confirmed. We are our own worst enemies. How do we overcome this hurdle? Stop making emotional decisions and let logic and data drive our decision making process.
What is the best vehicle for accumulating long-term wealth? This is a question worth thinking about as an investor and a recent Gallup poll shows that only 37% of those surveyed believed that stocks were a good method for accumulating wealth. This isn’t surprising. Over the past 13 years we’ve lived through two stock market crashes of 50%+ with very little overall growth over that period. But let’s take a longer term view of this. From the Investors Friend blog, we see this chart comparing the returns of stocks, bonds, gold and the dollar. It is pretty clear who the winner is of these options:
So, are stocks the only game in town? No, other investments to consider would be real estate and private businesses. Active ownership of a private business is probably one of the riskiest and most effective methods for accumulating wealth. If you go through the list of the richest people on the planet, most acquired their wealth through this method. Realize that most private businesses fail, so for every successful entrepreneur out there, there are probably 20 or more that have either seen their business fail or have not generated significant wealth through this endeavor. Stocks are one of the better choices for most investors since they allow you to take a passive stake in a company versus some of the other options that require more active participation.
This chart is another example why every investor should have some portion of their portfolio allocated to stocks. They allow you to participate in the profits of some of the best and well managed companies in the world. In addition, the long-term results speak for themselves.
If you were to ask most investors what is the least risky investment you can purchase you probably wouldn’t be surprised to hear treasury bonds and gold as their answer. Treasury bonds are literally considered risk free assets as they are backed by the full faith and credit of the United States. Gold has historically been known as a great “store of value”. The thought goes that countries can devalue their currencies but gold will always hold its value through periods of extreme inflation or deflation.
So let’s say going into 2013 you were worried about the upcoming year. You’d probably have quite a few reasons to feel that way. Although it was a long time ago, you probably remember the “fiscal cliff” fiasco, strained government negotiations, higher tax rates, sequester spending cuts, and the upcoming rollout of Obamacare. In anticipation of these events you might have decided that this was a time to get “safer” with your portfolio, allocating a healthy dose of gold and treasury bonds to your portfolio mix. Let’s take a look at how you would have fared.
Treasury Bonds (as measured by the TLT ETF) is down around 12% this year. Gold is down 25% for the year. The point of this post is not meant to say these investments should not be in your portfolio (well, maybe not gold), but that trying to outsmart the market by re-positioning portfolios based on what direction you think the market is going is a dangerous game. The other lesson we have learned is that even perceived safe investments can lose money.
From an insider’s perspective the last few weeks seemed to be the perfect time to be a gold investor. We had the government shutdown causing a slowdown in economic activity and even more importantly, it looked like we were heading for a potential breach of the US borrowing capacity which had the potential to cause a default. In times of great uncertainty (which is probably an understatement from the past few weeks), gold is often thought to be the investment of choice. This was such common wisdom that Goldman Sachs came out with a research report that gold was a “slam dunk sell” once the crisis was over since that was when the uncertainty would be removed.
There is an old saying that markets tend to do what makes the most people uncomfortable. Gold is no exception. Here is the chart:
So, gold fell through the lead up to the shutdown and until it looked like a deal was going to be reached. So during the period of maximum uncertainty, gold fell. Once resolution to the crisis was in sight, gold has been climbing. This tells us two things that we already knew. First, gold is not the great diversifier that everyone thinks it is. We saw this over the past few weeks and we saw it during 2008 as well. Second, no one can predict how the market will respond to events. The more certain you are, the higher the probability that you will be wrong.
Last week we saw everything sell off…US stocks, foreign stocks, REITs, US bonds, commodities, gold. You name it, and it lost money last week. There are times when diversification just doesn’t work as expected. As a long-term investor it is important we handle this appropriately:
- Get some perspective- there are periods where nothing seems to work. It doesn’t mean you should change your strategy, just realize going in, this will happen time-to-time.
- Check your emotions- losing money is emotional. If you are wanting to make changes to your portfolio, ask yourself honestly, “Do I want to make this change because I am afraid of losing more money or do I really believe my strategy is not effective anymore?”
- Realize you will look stupid- most good investment strategies require you to look and feel stupid in many instances. In times like these doing nothing while the market goes down is agonizing. Even still, adding money to an asset class that has lost value, only to see it continue to drop takes tremendous courage. A good investment strategy will have you making incorrect short-term investment decisions since no one knows how the market will react day-to-day.
- Stick to your guns- if your strategy calls for buying when assets drop below a certain target weighting, make sure you do this. Rebalancing portfolios (especially in times of market turmoil), is one of the best ways to react. Don’t be afraid to stick to your guns, as this is one of the hardest things to do during these periods.
- Focus on long-term results- in the fall of 2011, the market had taken quite a beating. Europe was a complete mess and the perception was the US government was completely inept. Global markets had lost more than 20% of their value in just a couple months. At that time, we wrote this to clients:
Greenspring continues to manage client portfolios using a disciplined process. Because of that strategy, we are close to repositioning some of our bond positions into stocks. If the stock market were to fall another 5 percent, our strategic allocation to equities for most clients would drop below our acceptable threshold and prompt a buy. While we don’t know if this would mark the ultimate bottom, we have found that this strategy tends to work well during market declines, as we are able to pick up quality holdings at cheaper prices. While it may seem counterintuitive to buy when everyone else is selling, we have found that following the herd tends to lead to herd-like returns, which unfortunately have been dismal.
When you focus on long-term results and try to block out the short-term noise, things seem to be a little more clear. Those of us who believe in markets, know that 10, 20 and 30 years from now, there is a very good chance of higher stock prices. When we view the market in this type of context, these times of trouble, actually end up as times of opportunity.
Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.