Prudence may mean increasing diversification, reducing portfolio beta, or simply resisting the urge to chase the latest fad. None of this caution may seem necessary today, and may not be in the future. But, on the non-zero chance that it is, a little bit of prudence will go a long way.
The equity markets in the U.S. have been unusually calm thus far in 2021, with the S&P 500 already posting 52 all-time highs and doing so without a pullback greater than 5% (on a closing basis). Investors should not view this as a sign that risk has been eradicated. There’s always risk lurking beneath the surface; you just don’t always see it.
Of all the things that you should do during a melt-up, the most important is to get invested.
Volatility is basically non-existent this year. Not only have there now been 50 new all-time highs through the close on 8/23, but just three days in which the S&P 500 was down by 2% or worse. In contrast, last year saw 25 down days of 2% or worse. That includes the 16 days with losses of 3% or worse. The worst daily loss in 2021 is just 2.6%.
Emerging markets are starting to look more like the S&P 500® Index over time. Eventually, that should be a good thing for investors in these volatile markets
These are the charts and themes that told the story of the first half of 2021. As always, the narratives followed prices. As prices change in the back half of the year, the narratives will change as well.
As children, we’re taught that the shortest distance between two points is a straight line. Many expect investing to be the same, with high and consistent returns bringing you from point A (starting out) to point B (wealth). But markets don’t operate in the same realm as the physical world. There is no straight line when it comes to risky investments. Instead, the road to wealth is a long and winding one – two steps forward, one step back – repeated indefinitely.
Is the traditional 60%/40% portfolio a thing of the past?
The question for U.S. investors today is not whether home bias has helped. It most certainly has. The question is whether it will continue to help going forward. And because no one knows the answer to that question (we can’t predict the future), we need to diversify to protect ourselves from the unknown.
S&P 500 valuations are at their most elevated level in history with the exception of the dot-com bubble. It wouldn’t be unreasonable for investors with a lower risk tolerance to be seeking out lower beta options in preparation for more difficult years ahead. High yield bonds have proven to be one such option over the past 35 years.
Historically, the best protection against a bubble or elevated valuations in a single asset class is to have exposure to other asset classes and strategies that do not have the same underlying fundamental drivers. This is ultimately an exercise in humility and risk management. Diversification, at its core, is an admission that you cannot predict the future and is employed to protect oneself from the many possible outcomes that lie ahead.
Knowing what you own and why you own it may be the most important rule, but it’s just the beginning of the investing journey, not the end. Once you understand the “what” and “why” the hard work begins.
When secular trends reverse, no bell is rung, and no one can believe that a shift has actually occurred.
But as narratives follow prices, the longer they are sustained, the more the story changes and the more people believe it. In January, there were few believers in a change to the status quo. Today, as the great reversals have continued, there are more believers.
Spreading your money across a wide range of investments, asset classes, and geographies is the ultimate form of saying, “I have no idea what’s going to happen in the future.”
For those of us who cannot predict the future, we diversify.
A reminder that it feels like this every time. Every time stocks fall a little, it feels like they’re going to fall a lot.
What has served as a tailwind for decades (falling rates) is now a major headwind for bonds. There is simply no escaping bond math in which lower yields portend lower future returns.
If the year ended today, it would be the worst ever for Aggregate Bonds, slightly edging out 1994. Interest rates are rising and there is little cushion from the coupon to soften the blow. For those that equate bonds with safety, this can be a tough pill to swallow. But bearing that risk is the price of admission for long-term bond investors.
Interest rate levels, in and of themselves, aren’t the sole cause of every market movement. They are just one factor among many that impact how people allocate their assets.
And maybe, just maybe, they don’t matter as much as we all think.
An objective observer will note that the risk/reward in U.S. equities is less favorable today than it has been in quite some time. That says nothing about what will happen tomorrow, but if the price one pays for something still matters, it will be a factor weighing on returns for years to come.
The problem with the current rate environment is we’ve never experienced interest rates this low before. Maybe investors will become spooked at lower rates than they have in the past. Maybe markets will be given the benefit of the doubt if the economy is chugging along. The truth is there is no rule of thumb with these things. But rising rates, in and of themselves, don’t always spell doom for the stock market.
Declines in stock prices and the fear-inducing narratives associated with them are the price of admission for long-term investors.
Looking through 93 years of returns for stocks, bonds, and cash won’t help you predict future returns for these asset classes. But it can give you a better sense of the risk involved in these asset classes since risk is much easier to predict than returns.
It's always hard to see things changing. And then along comes a year like 2020. Nobody had any of this on their list at the end of 2019. 2021 is sure to deliver some surprises, and unlike the last dreadful year, hopefully, they're for the better.
You can always change someone’s mind about the markets by simply changing the start and end dates for your return series.
2020 may look easy with the benefit of hindsight, but it most certainly was not for those of us who lived through it. If you survived 2020 as an investor without making an avoidable or unnecessary mistake, you outperformed this year.
Just when you think you have the markets figured out, the narrative changes before you even have time to react.
Investors don’t have a great track record when it comes to chasing the hottest fund of the day.
Ten lessons and perspective on the year.
2020 looks like it could go down in history as the worst intra-year drawdown that finished the year with a positive return. And the fact that those gains are now in double-digit territory is not something many (any?) people saw coming. The S&P 500 Index is now up well over 60% since bottoming in late-March.
Although the 2020 stock market is something of an outlier, it’s not out of the ordinary for stocks to see gains on the year despite large losses on the way to those gains.
Timing the market is hard for a plethora of reasons. Markets are right more often than people give them credit for. The direction of the stock market is impossible to predict in the short term. And, even if you get lucky by getting out at the right time, you still have to get back in at some point. Market timing requires being right more than once.
Three reasons to own bonds:
- Bonds Tend to Rise When Stocks Fall
- Bonds Can Provide Added Return Through Rebalancing
- There Is No Alternative
The stock market has been all over the map this year. And, while 2020 is an outlier in terms of the wild ups and downs, volatility is something every investor is going to have to get used to in the coming years. You simply have to be willing to accept some form of volatility if you would like to earn anything on your capital.Volatility has always been part of the markets, but more so now than at any other time in history because interest rates are on the floor.
If you’re not a short-term trader, then you’ll see that all-time highs are nothing to fear. Returns are actually higher 6, 12, and 24 months out. This isn’t a shocking revelation. Rising prices attracts buyers, it’s that simple. All-time highs are not an all-clear signal, no such thing exists. But neither are they a sign that the rug is about to be pulled.
There are no easy answers, but the only sound advice when dealing with irreducible uncertainty about the future is to focus on what you can control.
Individual stocks are often more confusing than the market itself and can lead to some contradictory outcomes, depending on your time horizon and which types of stocks you’re looking at.
2020 is unprecedented for the number of times people have called it unprecedented. This year certainly is unique. But stock market volatility is not.
The reasons change but big moves in the stock market are nothing new.
The stock market bottomed three months ago. In the 65 trading days since, the S&P 500 Index gained 41%, the strongest move off a bear market low in the history of the Index.
We feel losses harder than the we feel joy from an equivalent gain, so in order to protect ourselves from pain, we want to know all the things that can go wrong.
2020 is a case study in the power of simplicity when it comes to portfolio management and investment decisions.
There have been two massive moves in the stock market this year (and this year is still not even halfway over). Once you start digging into the historical numbers, you begin to realize the stock market is even crazier than advertised. Surprisingly, huge up and down moves happening in the same year is not that out of the ordinary.
It feels like we’ve already lived through 3 different cycles that would normally take place over the course of a number of years and 2020 hasn’t even reached the halfway point yet.
You have to account for luck in the investment process. No one can prepare for good luck, but there are ways to manage bad luck. Diversification is one of the best tools available to avoid allowing bad luck to give you extreme outcomes at the worst times.
Fundamentals are more complex than they seem. One of the simplest, yet most overlooked, stock market fundamentals is the dividend yield. Dividends also happen to be one of the most resilient features of the stock market over the long-term.
The history of the markets shows nothing lasts forever. Investors have been waiting years for the biggest stocks in the stock market to falter and they’ve done just the opposite.
One hard part about investing during such highly volatile periods is you can talk yourself into just about any scenario. Sometimes these huge bounces are the real thing. Other times they’re a mirage. By studying historical downtrends and volatile markets, we learn that they tend to open you up to a wider range of outcomes, both to the downside and the upside.
Which portfolio is right for you? The one that you can stick to. And to find the portfolio that you can stick to, you have to have some idea for the amount of risk you are willing to bear.
A picture is worth a thousand words. In each issue, we present one insight on a range of market, investment strategy, and behavioral topics. The 1000 Words Series is designed to provoke insightful and memorable conversations.
Trying to pick the best times to be in the market and when to be out is known as market timing. Unfortunately, trying to time the market to miss the lows means missing the highs too.
Bull markets tend to climb slowly over time, while bear markets drop abruptly without warning, often causing extreme volatility.
Inflation erodes your purchasing power slowly, but surely, even when the figures are small.
Investing may be simple, but it isn’t easy. We’re told to buy equities and hold them through good markets and bad. But few of us have the fortitude to calmly stay fully invested when prices are declining. When it comes to investing, your best offense is a great defense.
This guide strives to help you achieve better long-term financial outcomes. Its main message is that doing so is more about setting the right goals and controlling your own behavior than it is “beating the market.” We provide plenty of historical perspective on markets, but only in the service of confronting our natural tendencies to make poor decisions about money.
There are four steps to calculating your "retirement number" - the number of dollars you most probably need as a sum of capital from which to draw a lifestyle-sustaining income without serious danger of running through the capital.
Recent financial innovations have created both a wealth of opportunity and an avalanche of complexity for investors. It has never been easier—or more overwhelming—to take investment risk. With complexity comes the need for simplification. How do investors cut through the noise and take control of their portfolios? This guide offers perspective on the so-called active and passive investing debate, with an eye toward prioritizing diversification, risk management, and investor behavior.
Market leadership changes from year to year and predicting the winning style is impossible. These tables highlight the importance of diversification.
Country leadership changes year after year — but it’s not possible to predict future winners.
Diversification is the answer.
Sector leadership changes year after year — but it’s not possible to predict future winners.
Diversification is the answer.
Asset class leadership changes year after year— but it’s not possible to predict future winners.
Diversification is the answer.