History does not repeat itself, it rhymes...

In my 28 years in the investment business I experienced the Dotcom bubble burst in the late 90’s, the Asian crises in 1998, 911 terrorist attacks in Sep 2001 and the financial crises in 2008. Prior to me entering the investment business the markets dealt with the depression of 1929, WWII from 1939 to 1945, the oil crisis in 1973, Black Monday in 1987. While these events are all very different, they have one thing in common and that is how certain investors react. This is no different, to quote the late Sir John Templeton “The four most dangerous words in investing are ‘this time it’s different”.

The second thing all these events have in common is that the pendulum always swings too far regarding the stock market. There are only two emotions that drive the stock market prices and they are greed and fear. We are clearly in a fear cycle with retail investors selling stock only because others are selling and not for any fundamental reasons. Fortunately, we hire professional managers to manage our client assets. In these times managers are working extremely hard in deploying cash they have on hand. I have noticed that the cash positions in some of the portfolios we hold have reduced quite dramatically as managers are bargain hunting, while this might not benefit the accounts in the next few months it will make a substantial impact over the mid to long term. A point to note is that we do not get many opportunities in our lifetime to buy great companies at substantially discounted prices. We need to stick to our plan and focus on the mid to long term, we simply cannot make decisions based on short term market movements, that is a dangerous game to play. I have attached is a graphic that sums this up nicely.

Things to consider:

One of the most common statements I get from clients is “I don’t want to see my investments go to zero”. Consider all the critical historical events that I listed above and know that the markets have never gone to zero. The second statement I get is “I don’t have 10 years to recover”. In 2008, which was the worst market downturn since the depression most client accounts recovered within 18 months and in some cases 24 months.

Always remember that when you are watching the stock markets on TV or on the internet always ask yourself the question “How much of this applies to me?” Most of my clients hold bond funds as part of their portfolios meaning that part of their portfolios are not even exposed to the stock market. The second consideration is the way we diversify the portfolios. We diversify by asset mix based on a clients’ risk profile. Asset mix is the split between stocks, bonds and cash. We also diversify by sector meaning that we have exposure to all parts of the economy, examples of sectors would be financials, consumer staples, energy and technology. We finally diversify by market capitalization meaning the size of companies. We mostly have exposure to large companies but have some exposure to medium and small companies. This all falls under the category of risk management.

Understanding the difference between risk and volatility:

Risk is something that we control in a portfolio by adhering to a client’s risk profile. Volatility on the other hand is out of our control and is what we are currently experiencing in the stock market. We use risk management strategies to reduce the impact of the volatility thereby reducing the risk in the portfolio. It is important to understand this distinction.

For the twenty years ending 12/31/2015, the S&P 500 Index averaged 9.85% a year. A pretty attractive historical return. The average equity US fund investor earned a market return of only 5.19%.

Why is this?

Investor behavior is illogical and often based on emotion. This does not lead to wise long-term investing decisions. Mistakes to avoid:

Don’t buy high

Don’t overreact

Never sell when down

Trust the investment science