Diversification helps allay fear as uncertainty rules the market
• Overcoming trepidation about investing is necessary as uneasy times are not unusual
Warren Buffett is often quoted as saying, “Be fearful when others are greedy”, warning us to be careful of high-flying assets coming crashing down.
This raises the question of whether the “others” are being greedy now. With the Dow Jones breaking through 22,000 and the disconnect between our market and economy, it seems a good time to ask.
The problem with the mass of information available to us is that it’s easier than ever to latch on to a narrative that fits our world view. In the financial markets, this makes it harder than ever to gauge investor sentiment. Rather than being greedy, it might be that investors continue to put money into equities because there’s simply nowhere else for it to go.
As Oaktree Capital’s Howard Marks puts it: “People may be thinking in not a bullish way, but acting in a bullish way. What would make them do that? Rates near zero. And when you live in a low return world, you have to take risk to get return. People are willing to take risk because they’re handcuffed volunteers, not because they want to, but because they have to.”
Two years ago, research firm Morningstar asked readers on its Personal Finance discussion board about their investing fears. The conclusion was that they were afraid of everything: stocks, bonds, and even cash were making them nervous. They’re likely to be even more afraid of everything today.
As one put it: “Stocks are reasonably valued only by comparison with bonds, and [US Federal Reserve] policies make it impossible to assign a rational value to bonds for comparison … the scariest thing may be emerging market securities. On the other hand, they may be the only thing that is fairly valued! The last time I felt this way was 2008 … the scariest possibility is everyone heading to the exits at the same time, as in 2008. What [was] safe then is probably not what my assets are in now because of low interest rates.”
But if these seem like uneasy times for investors, hasn’t this always been the case? Was buying gold below $400/oz in the ’90s any easier than it is buying at today’s prices? It might seem that way, but at the time you had to overcome the growing belief that it had lost its former use as a “hedge” against inflation and political crises after it became range bound. As someone once explained, “I bought when I thought it went as low as it could, but then it kept dropping. It dropped again after seeing it try to recover. So now I wait for another upturn-downturn, anything but stagflation.”
That doesn’t sound too different to the Morningstar respondent who complained after buying an ETF representing a basket of precious metals (gold, silver, platinum and palladium) that the problem was he’d never heard anyone able to assign a “rational” value to gold (the largest holding). “So valuation is questionable and metals have been in a downtrend the past couple of years. Then there is the fact that inflation is tame and the dollar could become stronger.
“I question if any positive return can be had at all, much less a positive real return net of expenses. But for all the negatives, it is more of a play on an uncorrelated asset that will zig when others zag.”
There you have it, “thinking in not a bullish way but acting in a bullish way”.
For some it isn’t the investments themselves but the financial system in general that is the biggest cause for concern.
“These supposedly educated people have made some very stupid decisions, out of greed for self, with little concern for anyone else … then there’s the fact that my investments are in the digital vault that runs the risk of been hacked by a teenager.”
There’s good reason to fear bonds too. As one 72-year-old retiree said: “With a bear market on the near horizon, bonds are usually the safe harbour. But, not now with interest rates almost assuredly soon to go up. Everyone says that at my age I need a greater percentage of bonds but I don’t feel that way. Interest rates can’t stay this low forever, and so I’ve been reducing my percentage of bonds.”
Creating another set of reluctant equity buyers.
Even cash — seen by many as the safest of all investments — has those who fear it. “What scares me most is cash,” said one Morningstar respondent, “inertia and fear of another 2008 has caused me to keep my money on the sidelines. I don't see any good investment options for money I might need in the next five years or so. At the same time, holding that much cash is scary because of what inflation is doing to it and — worse — what inflation could do to it in the future. It’s been downright painful too with the market setting new record highs. The market may be too high to buy, but we’re certainly not making any real return with cash.”
“There is only way to deal with all this fear,” says Adam Zoll at Morningstar, “serious diversification both in regard to assets and to types of accounts.” But, as he points out, while that may make things a little less scary, “it won’t get rid of the bogeyman in the mirror”. What you probably need to be most afraid of is yourself; the greatest risk right now may be to succumb to your fears and change your portfolio from a winner to a not-so-good or much-worse.
Younger investors are not immune. As one Morningstar respondent said: “The scariest thing in my portfolio is the button that lets me buy and sell. I’m much more afraid of me than I am of the markets. My wife and I are in our early 30s and our retirement savings are invested 100% in equity index funds.
“What I worry about the most is how I respond to the next big downturn. I’m happy with my asset allocation plan and I have a lot of confidence that I can stick with it. But I still get scared because of all the financial press that tells me I’m going to freak out when the portfolio loses 40% of its value.
“We had accumulated enough in 2009 for it to hurt a bit when the portfolio balance shrank. But I didn’t really know what I was doing at the time, didn’t pay as much attention and had a somewhat more forgiving asset allocation.
“I was more confused than frightened. Since then I’ve learned enough to be able to be stupid. And that scares me.”
WHAT SCARES ME MOST IS CASH. FEAR OF ANOTHER 2008 HAS CAUSED ME TO KEEP MY MONEY ON THE SIDELINES