Markets go down and up! Dr Benjamin Holdsworth looks at the lessons to be learned from the last year.
As an investor, one is always learning. Our perception of investing is guided by our experience.
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 12 months, we have been reminded of some useful lessons that can – hopefully – make us all better investors.
Several key lessons stand out:
1 Markets go down as well as up
In the decade following the global financial crisis, investors were treated to a long and almost uninterrupted 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.
2 Short-term pain does not become long-term pain unless you sell
Those who need 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 do not 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.
3 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 – that is to say, 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.
4 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 25 January 2021.
Social media pumping of stocks like GameStop and the ‘enthusiasm’ of online retail investors pushed some stocks ‘to the moon’. 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.
5 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 – that is to say, $1,900,000,000,000 – package in the US, risk fanning inflation. Inflation is a form of unlegislated, invidious taxation.
6 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.
7 Gold is not a good short-term hedge of inflation
The salaries of comparably ranked army officers from Roman times to today – a mere 2,000 years – are almost identical in gold terms , which means the price of gold has kept up with inflation. But just as we are potentially experiencing a rise in inflation, gold prices have been slumping from above £2,050 per ounce in August 2020 to below £1,700 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.
8 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.
These lessons lead us to some obvious conclusions about portfolios. We should 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 us to meet our nearer-term liabilities.
We should also 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.
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.
Dr Benjamin Holdsworth (right) is director of Cavendish Medical, specialist financial planners helping consultants in private practice and the NHS
The content of this article is for information only and must not be considered as financial advice. Cavendish Medical always recommends that you seek independent financial advice before making any financial decisions.
Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. The value of investments and the income from them can fluctuate and investors may get back less than the amount invested.