Part 1 of the Series: Rethink the Way You Invest
You’ve no doubt seen more than your fair share of the “Keep Calm” slogans on the internet. What you may not know is that the original slogan “Keep Calm and Carry On” poster was printed by the British Government in 1939 in preparation for WW II and the widely predicted air strikes on their major cities. The panic today is self-inflicted.
The advice still holds today amidst the uncertainty following Britain’s decision to exit the European Union. The advice should be the same in any market downturn for one major reason: No one invests to lose money.
Although most market downturns have people wondering about that, history does not lie. In the long run, markets throughout the world have a history of rewarding investors for deploying their capital in proportion to the risk they are willing to take. Their expected returns offer compensation for bearing the various risks involved.
The U.S. stock market is the biggest in the world and gives us statistics that are longer than those in Canada, so I’ll use them as an example. From January 1926 through May 2016, the entire universe of US stocks gave us an average compound rate of return of 9.76%. During the same period, “safe” U.S. 1-month Treasury Bills gave a 3.40% compound rate of return and inflation averaged 2.91%.
To calculate the “real rate of return”, we subtract inflation from the rate of return. After that bit of basic math, the real rate of return of the U.S. stock market has been 6.84%, while that of Treasury Bills has been 0.5%. You’ve probably seen enough compound interest calculations to realize that 0.5% is going to slowly and steadily get you broke very safely! That’s not bad for short to mid-term goals, but it can be catastrophic in the long run.
If we dig a little deeper (and we will in future posts), we also know that the folks who invest in the smallest and most out of favour stocks will do better than those who invest in the biggest and safest companies. Why? Simply because the market tends to reward investors who take higher risks
An “efficient market” or equilibrium view assumes that competition in the marketplace quickly drives stock or bond prices to fair value, ensuring that investors can only expect greater average returns by taking greater risk in their portfolios. Lightning-fast information and trading technology has virtually eliminated the advantages once held by even the smartest professional money managers. In this environment, the best thing that investors can do is to identify the risks they are willing to take, position their portfolios to capture these risks through broad diversification, keep their costs low and stay in the game through the highs and lows.
The long and short is that no one is smarter than the market. If I take a position that a certain stock is worth more or less than its current market value, I’m essentially claiming to be smarter than the market. I’ve come to the blissful realization that I can never do that without lying.
Click here for Part 2: “No Free Lunch.”