The Emotional Cost

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A recurring theme of our market observations over the last couple of years has been the hugely uneven levels of market volatility.

2017 was unusually benign which everyone loved and 2018 has been full of volatility which everyone dislikes greatly.

We know that over time markets will on average rise, because of the growth of the economy and inflation. It’s actually not that difficult to predict the probable growth rates of all the main asset classes over extended periods. This really is the point of buy and hold investing, don’t worry about the shorter-term fluctuations because longer term the averages will assert and patient investors will be rewarded.

The kicker to this buy and hold strategy is to allocate funds to investment managers who are elite in their fields and who will add additional performance over time above the markets’ growth.

That’s basically it really; that’s all anyone needs to do to end up with highly satisfactory results.

Add on to that good tax planning and consistently well informed and intelligent actions and the job’s a ‘good’un’.

So, in essence successful investing is pretty straightforward, but if only it were that easy.

The challenge that defeats most people at some point is the emotional toll when markets are falling. Consider that assets have been traded for hundreds of years in which time there have been world wars, near nuclear war, massive natural disasters, deep economic recessions etc. Now engage with the reality that on average over that period their performance has been as expected, prices have risen by the amounts they should have, given growth of economies and inflation. There have been ups and downs from these averages but over longer periods the growth returns to the long-term trend line.

Money is not lost because of these gyrations, it is lost because the emotional toll on investors often causes them to sell at low points thus crystallising the loss.

We know that clients crave certainty and want to believe that the near-term future is knowable, but the inconvenient truth is, it’s not.

The single most important skill of a successful investor is to understand and accept that price volatility and the resultant emotional discomfort is ‘the cost’ of making long term gains.

Some thoughts on the current issues

  1. Brexit is a ‘bloody mess’ and from a U.K. perspective has the real potential to cause negative outcomes for years (the property market is already wobbling; down 1.4% this last month in a survey released today). Nobody knows how it will play out but if a reasonable resolution is achieved it won’t come easily. The logical, sensible way to mitigate these risks is to diversify investments globally which the portfolios do.
  2. The US (post-Iraq and Afghanistan) has decided that from now on it will use economic tools to achieve its desired outcomes not military ones (no body bags). It’s now imposing economic sanctions on Iran, Russia and China and they are effective. This will continue and as long as Donald is in charge, they’ll be graceless. The truth though is that in each of the above cases the US has valid bones to pick as all three countries are properly ‘at it’ in varying ways. Everyone knows and accepts that free trade is the most rewarding model so pragmatism will prevail eventually. Equally it is better to fight economically than to drop bombs. Realistically it’s a truth that humans are territorial, aggressive and identify with their pack rather than their species. So, this nonsense of tribes, which has been the case as long as we’ve been on two legs, will be as it is because that’s how we are.
  3. The latest catalyst for the US market to lurch down temporarily this week was the much feared ‘inversion’ of rates in the Treasury market. This inversion simply means that short term rates become higher than longer term rates which historically has occurred when recessions were looming.

The observation by Churchill amongst others that history rhymes with the present (fundamentally repeats) is useful in essence but is not a truth.

If something happens which has never happened previously then the resultant by-products will not have historical comparators.

One example is with the current unwinding of the QE/ultra-low interest rate environment of the last 10 years, which is several books’ worth in itself. However, historic equivalents don’t apply as they have previously, once this singular occurrence is factored in.

The key to markets’ medium term health is growth; whether economies are growing and by how much, because asset prices will correctly increase by this level.

World economies are doing ok; the US is growing the most and Europe is a slug by comparison, but this was and is perfectly predictable and understood.

Conclusion

We set ourselves the goal of advising clients in the most effective and intelligent ways to achieve excellent results.

To do this we accept and embrace the need to keep repeating the ‘contra intuitive’ facts that few want to hear but are crucial to success.

  1. Volatility is a given; it will happen, it always has and it’s always scary and unpleasant but over time has always turned out more than ok.
  2. We don’t know what will happen next because nobody does. Our contention is that if anyone says they do then they are to be avoided.
  3. The richest investors in history have an investment success rate of around 65%.

They got about a third of their investments wrong.

The reason this is more than acceptable is just maths.

Gains can be many multiples of the initial investment, losses can only be the original investment.

Note: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.

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