Global Markets in "Bear" Territory - Oct 2011
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I had a client the other day ask me “ Why would a smart individual invest in these markets? Since 2005, has investing in stocks been a successful strategy?”
It gave me the opportunity to clarify my own thinking about a question that I suspect many people are struggling with these days. I thought it beneficial to type out a few words to help dispense with the concerns and fears that are out there.
To put this into context, since 2005, the world stock markets have produced, on average, a negative rate of return. His question was clearly meant to be rhetorical, under the assumption that the answer was a given - namely, since stocks were down for the past 6 years, investing in them must have been an unsuccessful strategy.
As part of my response, I asked the client if he could give me a definition of what “success” meant to him when it came to investments. He thought the answer was, once again, obvious, that success is measured by a steady gain or return.
As I get a little older (and greyer), however, I have become increasingly cautious of things that are “obvious”. Let me give you a few examples why.
In the 1990s, it was obvious to most investors that investing in Nortel was a successful long term strategy. In fact, in 1999, I had a conversation with a gentleman that was an engineer at Nortel, about diversifying his 6 million dollars in shares into a broader portfolio.
The gentleman who was 64 years old at the time, had everything invested in Nortel - his retirement purchase plan and all of his savings. His response was, “Mr Montcalm, I’ve been told by people like you to diversify ever since I started putting all my money in Nortel. If I had followed that advice, today, I’d have less than $600,000.”
At the time, he was absolutely right. Had he invested his money in a broad portfolio instead of a single stock, his net worth would’ve been only a fraction of where it stood that day. So far, his strategy of investing in this “obviously” successful stock was paying off big time...
Within a year, the value of his Nortel shares dropped by half. He was still independently wealthy, it still wasn’t too late to cash out his remaining $3 million in value, and invest it in a more balanced way.
Of course his thinking was he had no intention of selling. In fact, if he could have, he would be buying even more Nortel shares at these “low” prices.
We all know what happened next....
My definition of investment success is a portfolio that delivers the results you require, over the specific timeframe you set for that investment.
If your timeframe is a year (meaning you’ll need to have access to that money within the next 12 months) then you should invest it in something that’s guaranteed not to lose money.
If your timeframe is rather longer - like, say, a retirement plan that needs to span more than 30 years - then you will need a portfolio that can deliver a return substantially in excess of inflation, over the course of a 30 year period or longer, without your money running out of time before you do.
Let’s take everyone’s current favorite investment as an example; gold.
Last month, gold briefly topped $1,900 an ounce.
All summer long, investors have been piling into gold despite the fact that, as an asset class, it has no earnings and no chance of income. In fact, over the last 30 years, gold has barely kept up with the rate of inflation - and that’s including this latest, frenzied run up.
These same investors have likely been selling stocks (which are arguably currently under-valued) to buy this asset (which is sitting at an all time price high). Moreover, the stocks they’re selling to buy gold represent ownership in companies that have earnings, pay dividends, and which are steadily growing their earnings year after year.
I don’t know if gold will keep going up from here, (it certainly hasn’t in the last two weeks....) or for how long. But it strikes me that all these investors who are chasing after this one asset class may not have thought carefully enough about their definition of success, their timeframe, or the likelihood that their investment choices today will be able to deliver on their long term goals.
There’s no doubt about it - we’re living in unusual times! Flat 10-year returns and global debt crises have driven markets down. Today, stocks are relatively inexpensive, and in many cases, their dividend yields exceed those of 10-year Treasury Bills.
Given all that’s happened over the past few years, investors can certainly be forgiven for their frustration and impatience with stock market fluctuations. But putting frustration in the driver’s seat of your long-term goals is a good way to end up in the financial ditch.
When you’re picking a portfolio that will meet your goals over the long term - make sure it’s one that can get you there from here, and one that you’re comfortable with and understand.