Financial freedom is bumpy
ONLY ABOUT 50% OF DAYS IN A YEAR ARE POSITIVE WHEN NAVIGATING STOCK MARKET Make sure you’re in the right place at the right time.
Iam currently rereading The Psychology of Money: Timeless Lessons on Wealth, Greed and Happiness by Morgan Housel. It is a book that I strongly recommend to every individual; it’s a quick and great read.
In the book, Housel explores the “strange” ways people think about money and the role of luck and risk in financial success. In this article, we will focus on risk.
French writer Voltaire once said: “History never repeats itself, humanity always does.”
However, markets and economies react differently than we expect – there can be growth amid uncertainty and chaos.
For instance, let’s look at the US economy over the past 170 years, as outlined in the book:
Roughly 99.9% of all companies that were created went out of business;
Four US presidents were assassinated;
33 recessions lasted a cumulative 48 years,
The number of forecasters who predicted any of those recessions rounds to zero;
The stock market fell more than 10% from a recent high at least 102 times;
Stocks lost a third of their value at least 12 times; and
Annual inflation exceeded 7% in 20 distinct years.
However, despite all these events, the S&P 500 index, which tracks 500 of the largest companies listed on stock exchanges in the US, is at an all-time high (5 074 as at time of writing). This year was the first time ever it broke through the 5 000 mark.
I would like to define risk again. There is a difference between risk and volatility (or market cycles), which is incredibly important to remember specifically when approaching your investment portfolio. It’s worth remembering that what happens in your portfolio is driven by emotion. This is not a bad thing, as it means certain outcomes can be anticipated and priced in as well.
When one considers historic recessions, data shows the recessionary period doesn’t last forever. The stock market still recovered following recessions and was in a better position afterwards than before. The market always recovers. We just need to be in the right place at the right time when the recovery arrives.
I don’t want to detract from the fact that this will be a challenging year, with 70 worldwide elections coming up, interest rate cycles and inflation that needs to be tamed.
Yet understanding the behaviour of asset classes and market cycles helps us to digest these cycles, and noise, much easier. One asset class is not an alternative for another – they all play a critical role in any portfolio – but the percentage allocation towards each can change. But choosing one over another is like playing darts blindfolded.
When it comes to navigating the markets and ensuring a resilient investment portfolio, we need to first define what we see as “risk” and consider the strategy we are following.
To me, being invested 100% in cash is “risky”.
In the long run, cash is unlikely to outperform inflation, especially with interest rates forecast to come down. It’s just not as volatile as watching the stock market.
Equities just behave differently. They are volatile – yet you still have ownership of a company. You are not “losing” money – unless you withdraw and realise these movements in price.
A resilient portfolio includes different asset classes for a reason – they behave differently in market cycles. Cash and bonds provide short-term safe-haven returns when equities are volatile. Typically, when equities are earning substantial returns, this picture turns around. There will be exceptions.
Bonds are considered a safe haven asset class, yet in 2022, it was one of the few years on record that both equities and bonds experienced a terrible year – due to uncertainty.
The reality is that only roughly 50% of days in a calendar year are “positive” when navigating the stock market, if that much. You don’t want to miss out on these days.
They cannot be predicted (by anyone) – and missing out on merely a few of them will provide an entirely different outcome in your portfolio.