The below chart shows the value of the most important stock market in the world, the S&P 500. It is within spitting distance of an all-time high.
Source: Yahoo Finance
This performance is fairly remarkable considering all of the misery that’s out there in the world. In no particular order:
A recession in the US, and elsewhere, is considered an inevitability (and has been for the past year or so);
Inflation rates are still above central bank targets;
Cash rates and bond yields offer a proper alternative to stocks for the first time in a generation; and
The world is currently a very destabilised, and frightening, place.
All of these observations are perfectly sensible. There will always be very good reasons to be concerned for the world in general, never mind markets.
But time spent worrying as an investor is inevitably time which is wasted because the best companies in the world have, over many decades, shown an undefeated ability to adapt and grow their earnings through almost any environment.
So, if we have hundreds of years of market data that tells us that the current is always ultimately pulling in one direction – then why do we as investors spend so much time listening to the siren song of misery?
The great Morgan Housel has written extensively about this. Executive summary – pessimists sound smarter than optimists. Pointing out the myriad of risks to the market that are present at any given time, just makes you sound more intelligent. The optimist, despite always being proven correct eventually, sounds positively naïve.
Cynicism is just far more intellectually compelling, glamorous even. People write books about bullshit callers, they don’t write about folks who spend less than they earn and buy index funds.
But I believe there’s also an economic incentive at play here too for the asset management industry.
Expressing an optimistic view is very simple. You can go and buy a diversified portfolio of the world’s best companies for less than 0.1%. There isn’t much in the way of margin there - getting long has become commoditised.
The products that make far more money for the City are sold on the basis of something far more seductive. Protection. Strategies that can protect your hard earned wealth from all of the potential “bad things” that can happen out there. Active management that can skilfully negotiate the landmines. Capital preservation. Derivatives and options and complicated things. In other words, “a strategy you couldn’t possibly replicate yourself sir – so you can pay us 2% for the privilege”.
If you’re in the business of selling insurance, you need something to insure against. Hence the negativity. Combine this with the ego inflating consequences of sounding clever, and you have yourself a heady behavioural cocktail.
The vast majority of private investors (that is to say, you and I) have no need for such complication in our lives. The engine of growth within your portfolio should be a well-diversified, low cost portfolio of global stocks. You will naturally have some allocation to cash, and may very well own your own property. If the occasionally violent swings of the equity market are too much to bear, then you can add some (high quality) bonds to your portfolio to reign things in a little.
That’s four different asset classes altogether, which historically have shown low levels of correlation* to each other. That is more than enough.
When it comes to risk management, the most powerful tool that you have at your disposal is a good mindset. And the best part is, that it is free.
*When we talk about correlations from an investing perspective, what we are referring to is how investments move in relation to each other. If they move in very similar ways, they have a high correlation and vice versa. The shares of a company that sells umbrellas, would likely have a very low or negative correlation to the shares of a company that sells ice creams – you aren’t selling many umbrellas when its sunny and folk want ice cream!
The goal of diversification within a portfolio is to have a collection of investments that have low correlations to each other, so that you aren’t over exposed to one theme.
Comments