One interesting element to my job is trying to sort out certain types of investing dilemmas. The positive spin on this is explorations of unique portfolio construction concepts with innovative investment products. The negative spin would be trying to understand the context of being down 24% in a decade and seeing markets not function in the way they are intended as was the case for about 20 minutes on Thursday.One purpose of this site has been to provide a commentary to clients to do whatever it takes to help them to tune out the short term spasms, understand our approach and placing emphasis on things that are actually relevant to their financial goals. To the extent any reader who is not a client can benefit from this part of the dialogue; great, it feels like I could be offering something constructive to people.
The posts that seek out different theoretical ways to construct a portfolio help clients have some understanding of what I am looking at to try to smooth out the ride and for non-client readers maybe these posts offer a catalyst to think about how different asset classes and market segments interact with each other thus creating a more realistic expectation of how they will hold up during a panic. For example Chile went down puhlenty when things were at their worst but it ended up going down less and coming back sooner and that was the expectation I tried to set as opposed to some market not going down at all which is not realistic in a worldwide panic.
In the instant aftermath from Thursday there have been questions about what the malfunction (or whatever better word you have in mind) means for individual investors. Will this scare them away for good? Simon Hobbs rhetorically asked whether individuals should be in equities at all.
Most of this line of inquiry in more sensational than anything else although my constant pounding that foreign markets will treat money better over the long term could be viewed as contributing to the idea. Going back to 2000, or longer, this has been one event that has lasted for ten years so far. There have been other negative events that have lasted 10-15 years so this isn't necessarily new. Once this event ends then stocks will be viewed more favorably but if it lasts from 2000 until 2020 then a lot of people will have been effectively locked out from compounded growth rates. Anyone worried that this could be their reality needs to save more money. That may not be easy of course but that would be the answer.
Abnormal Returns had a post earlier in the week that was right on point. Another related post came from Felix Salmon responding to the Scott Adams post I mentioned. Felix titled his post Why Invest Retirement Funds In Stocks and keep in mind this was before Thursday's trading.
A ten year period where the US stock market goes down 24% and many other markets go down some similar amount is going to skew a lot of statistics making it seem like equities are not worth the risk or are broken or whatever. I imagine similar discussions in 1981 (what year was the famous Death Of Equities cover? 1979?) would have drawn similar conclusions as are being drawn now. That event ended and this one will too. When it does then equities will work again--I believe money will be treated better in foreign markets however.
Even during that rotten decade some markets did well. From its inception in July 2000 to December 31, 2009 the iShares Brazil (EWZ) was up 295%. Occasionally there were big declines of course and I have no idea if there any days, like Thursday, where it malfunctioned but over a ten year holding period it added a lot of value. The reason to mention the ETF is that many ETFs had pricing problems during the donnybrook on Thursday. At least one ETF we use was down 100% at one point. Obviously this was not real and while I hope anyone would be smart enough to realize this maybe not everyone did, maybe there were panicked phone calls.
Even if a zero print was completely bogus I'm sure there will be some folks that swear off ETFs for good because of it. One market that ETFs serve is individuals, funds are marketed toward being part of the solution for individuals and I believe they are indeed a great tool, albeit with flaws, for access. If a tool in part designed for individuals cannot work for them in a time of need then perhaps individuals are right to ask questions, are right to question the appropriateness of any equity exposure ever. Would a day of "malfunction" be more important than the value added of a ten year holding period? The way you answer that question will determine whether ETFs are right for you or not.
But anyone going down this road will need to save more money. Every choice has a downside. No equities means never worrying about the equity market but it means more money needs to be saved. I have trained myself to realize that the market goes down sometimes; this is guaranteed to happen. Despite the recent experience of 2008 it's as if some people forgot already that markets go down. If you know that markets have dropped before and you know that occasionally it will go down in the future, and you do know this, then there is no need to have an emotional response. In this light the focus should be proper asset allocation and, IMO, some sort of proactive defensive strategy like the one write about so frequently. Layer on top of that the understanding that no one can be correct at every turn and you should be able to navigate through.
And to repeat, if you really conclude that equities and financial markets can never be trusted again then you need to save more money and I would add that you also need to plan on working longer and for some people this will be the best solution.
Perhaps a more realistic hope for individual investors is a better understanding of volatility and asset allocation. This might lead more people to a portfolio that allows them to sleep better, worry less and understand what their numbers can and cannot do for them leading them to the conclusion about saving more and living below their means.
15 comments:
I am with you Roger --- its reality check time:
50% SPY 50% AGG portfolio is +1.3% on the year.
A long SPY / short Europe (IEV) portfolio is +8.6% YTD.
A 50% MDY / 50% AGG (bonds) portfolios high hit new all-time highs in April.
If you aren't managing volatilty, then you probably shouldn't be investing your own money -- give it to someone who does.
http://tinyurl.com/23jkn76
Even if someone turns $100,000 into $90,000 over a 10-year period by investing in the stock market, at least they've got $90,000 to their name. The everyman who steers clear of the market isn't likely to be socking away cash in bank accounts that whole time. I think the statistics show he'll be spending hand-over-fist.
So I think the potential cost of investing in equities is outweighed by the way the stock market motivates people to accumulate liquid assets. Let's face it, playing the market can be a very fun activity. When I buy a stock I get the same kind of satisfaction as if I'd bought something from Best Buy or Home Depot. But tossing paychecks at widescreen TVs is a sure way to retire poor.
So I think just about everyone should "play" the market a little, because most Americans would end up spending that money on something frivolous anyway.
I will repeat what I have stated hear in the past. Only one portfolio to EVER consider and that is the permanent portfolio. Do you want a portfolio that is structured for deflation, inflation, recessions, prosperity, etc... than the only way to accomplish this is to invest in 4 equal weighted asset classes, gold, equity, long term treasuries and cash (or short term treasuries).
S Drone- are you listening yet?
"playing the market can be a very fun activity"
Many people say the same thing about casinos and Las Vegas.
"tossing paychecks at widescreen TVs is a sure way to retire poor"
So is buying high and selling low.
Please, do yourself a favor and read up on investing and forget about speculating. I suggest books by Larry Swedroe, William Bernstein, Benjamin Graham, John Bogle. Make index funds your core holding. If you must "play" then limit yourself to a tiny fraction of your investable assets.
Always keep in mind that there is someone on the other side of your trades; likely a professional.
@ Eric: You got stopped out and now the markets are just gambling? Sorry things didn't turn but it seems like your mentality of the markets whipsaws as much as your stops did.
@ WH: fully agreed.
@ Anon 7:40. By your own words no investor in the entire world should even consider anything but your idea regardless of their needs and goals? I can appreciate sharing ideas but come on, but thats just ridiculous to advice people to not even listen to or think about alternatives.
all of this emotion and the S&P is UP on the year? just imagine the crazy panic that will ensue if the S&P actually goes -2% YTD, god forbid.
there are relatively simple strategies to deal with all of this volatility. and I will give you a hint, its not buy & hold the S&P 500.
Roger keeps saying it again and again - markets go up and markets go down. You simply must expect and plan for that. Bonds can bring some stability but, of course, in an inflationary environment bring returns down. That's about all we know about the future so we have to plan accordingly.
I liked Eric's comment; too many people don't save for the future. Even if their investments go down, they will be better off than if they didn't save at all.
I bought a duplex many years ago as an investment. For probably 15 years the value dropped down slowly but we did not wish to sell. Finally, we did sell but by then it had doubled in value. A nice surprise but the real gain was in the tax write-offs that we'd garnered over the years. It wasn't flashy or a very liquid investment but it was a good savings vehicle for us.
Eric,
One other thing, a sensible passive investing approach almost guarantees that you will never have the highest possible returns, but you won't have the lowest either. Over time, your results will be above average because you will have avoided all the drag constantly attacking your portfolio (bid-ask spreads, taxes, excessive expense ratios, commissions etc.) You'll have the opportunity to buy low and sell high...it is called rebalancing. It is very difficult to do, because you'll be buying when everyone elso says to sell and vice versa. You'll be ridiculed because most people think you need to be proactive, but the truth is that no one can predict future market behavior with any consistency.
I think techniques that Roger promotes (avoiding most of the down and capturing most of upside) do have merit, even Ben Graham discusses this to a limited extent. But, even Roger seems to be a mostly buy and holder (at least I think so) although not in stodgy index funds. It is essential to master the basics of asset allocation, goals, need to take risk etc. before moving on to more advanced strategies. I fear you are repeating some of the mistakes many of us have made and learned painful lessons from.
I sense you are a young guy serving your country with good intentions of building a nest egg for your future. I was you once and learned some hard lessons. I wish someone pointed me to the books I suggested when I was twenty something.
Passive investing doesn't mean buy and do nothing. Passive investing isn't only the SP500 as many think. Educate yourself. Admittedly, it is a boring strategy to most people and you'll never be the talk of the town and you won't feel the "casino" type rush.
I hope this helps is some way. Again, thank you for your service to our great country.
There seems to be little to be gained in the discussion today as there is not meaningful dialogue about what is wrong in the marketplace. I'm speaking of the negligence on the part of the exchanges. The exchanges have a responsibility to provide for some semblence of order when it comes to buy sell trade agreements. They are woefully deficient in their responsibility when it comes to such things as allowing High Frequency Trading. I can't participate in that game and expect an outcome I can live with and there fore am not participating. Once that gets fixed, I will be back.
@anon1101 - I wouldn't say this discussion isn't gainful. Discussing approaches to managing money is useful.
I do agree that more attention needs to be placed on what happened. I think the jury is out and many theories exist, but I bet it had to do with the NYSE shutting down for 90 seconds while the other exchanges stayed open. I think it shows that markets should stay open no matter what. If one market shuts down, the effect permeates. The phone should always be answered.
Of course, I bet Goldman made a mint on the chaos.
I agree the HFT needs to be addressed. Broker-dealers shouldn't be front running client trades anyway. This is what they are essentially doing.
@ Roger: I don't think this hiccup will deter individual investors from using ETFs. They certainly acted funky, but the other choice for most investors is mutual funds. With those instruments, you get one trade a day. At least ETFs provide liquidity during the day. They may not always work as this week showed, but on a big move down an investor can get out while the mutual fund investor sits and watches a drop. Plus, ETFs have cost and tax benefits as well.
Kirk to be clear my faith in ETFs as tools to include in diversified portfolio has not altered one iota just wondering whether it will turn some folks off.
If anything, the past 10 years have demonstrated the efficacy using market timing and asset allocation strategies. Market timing has been much maligned in the financial media for many decades now, but even if you used the simplest of tactics e.g. the 200 day moving average over the past 100 years, your ride would have been smoother and you would have beat the market. That said, market timing is a great way to make the ride smoother, but shouldn't be viewed as a way to beat the market.
I also think those who have ignored asset classes like foreign equities or commodities have done themselves and their portfolios a huge disservice.
Barry R. has a great piece on hft.http://www.ritholtz.com/blog/
This is a worth a read for sure. There should be a wide chasm between what traders can do and what they do to deserve being allowed to operate in the same arena with the retail investor. The retail investor has no chance of success with HFT involved and contrary to what some might think, they provide NO value to the markets liquidity.
Gambling? Who said anything about gambling? My point was that it's good for people to get hands-on exposure to the market, because ultimately they'll be better at handling their personal finances. That's all.
I know plenty of people who don't stray from index funds, and all they know is, "Fund X had a great year," or "Fund X lost me a ton of money." They really don't know why they're making or losing money, because they've never had to follow the market or research companies like diligent people who do some of their own stock picking.
There is a lot to be gained by making occasional trades in stocks. And as long as you do this with a limited chunk of your portfolio, it's worth some additional risk.
Show me a person who's only invested in funds, and I'll show you a person who doesn't know what a P/E ratio is.
John Bogle is only invested in funds. I think he knows a thing or two about P/E ratios.
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