Investing

A Great Diversifier to Hi-Tech

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Quiz!

Which is the best diversifier for US tech stocks?

  1. Cash
  2. Bonds
  3. US Value Stocks
  4. Emerging Markets Stocks
  5. Emerging Markets Value Stocks
  6. Bitcoin

A Great Diversifier to Hi-Tech

If you work in hi-tech, your financial position could be greatly influenced by the hi-tech cycle. Your income comes from hi-tech. In addition, If you have any stock options, stock grants or actual stocks of your company, they all depend on hi-tech. Even if you do not work in hi-tech, but most of your clients do, you are very dependent on this sector. When constructing your investment portfolio, it is worth being aware of this. It may be tough to diversify, if you believe that the strong run of hi-tech in recent years will never stop. To understand how a reversal is possible, note that valuations (price/book) of tech stocks surged in the past 10 years. This means that people are paying substantially more (price) for company values (book). This is in contrast to company values (book values) improving as much as the price gains, leading the price/book to stay flat over these years.

You may be discouraged by the fact that interest rates are low and expected to go up, and inflation has spiked. Commonly discussed candidates for moderating the risk of expensive tech stocks, including bonds and cash, can get hurt by rising interest rates and inflation.

There is a solution that doesn’t require accepting the typical low returns of bonds and cash, and without giving up the liquidity of stocks. This solution is especially helpful when interest rates and inflation go up. The solution is Value stocks, especially in other countries. When US tech stocks declined for over 10 years starting in 2000, Emerging Markets Value stocks grew substantially. This occurred at a time of extreme valuations for tech stocks, just like we are experiencing today. So, while any investor should be cautious of a concentration in high-tech stocks today, if your income is tied to hi-tech, you have a good diversifier available now.

Note that diversified Emerging Markets Value funds already have an allocation to high-tech stocks (while emphasizing lower valuations than typical), so they don’t require a separate allocation to high-tech.

Quiz Answer:

Which is the best diversifier for US tech stocks?

  1. Cash
  2. Bonds
  3. US Value Stocks
  4. Emerging Markets Stocks
  5. Emerging Markets Value Stocks [Correct Answer]
  6. Bitcoin

Explanations:

  1. Cash offers zero volatility, and seems perfectly safe. The issue is that it loses money to inflation. With a modest 3% inflation rate, you lose 50% every 24 years.
  2. Bonds offer low volatility, at a price of low returns. While they may seem compelling, they can decline when interest rates go up, and they can lose value relative to inflation.
  3. US Value Stocks are a good diversifier given that they are helped by rising interest rates and inflation, while tech stocks tend to get hurt by those. They are still subject to US-specific country risks, so are not the best.
  4. Emerging Markets Stocks diversify the US-specific country risk, but there is still better!
  5. Emerging Markets Value Stocks diversify the US-specific country risk, and are also typically helped by rising interest rates and inflation, while tech stocks tend to get hurt by those.
  6. Bitcoin is a currency, with no expected positive returns. But, it is far worse than cash, because it is extremely volatile. In addition, people were drawn to it in recent years given the high past returns, similar to tech-stocks. As seen recently, they can experience declines together with tech stocks. This is opposite of what some speculated, thinking that it may be a good inflation hedge.
Disclosures Including Backtested Performance Data

S&P 500 10-Year Returns if The Past Repeats

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Quiz!

Question 1: In the past 10 years, how much did the S&P 500 companies grow their book values (change in price divided by change in price/book)?

  1. 16.2%
  2. 6%
  3. -6%

Question 2: Last time the S&P 500 had approximately today’s valuations, what was its average annual performance in the following 10 years?

  1. 16.2%
  2. 10%
  3. -1%

S&P 500 10-Year Returns if The Past Repeats

The S&P 500 enjoyed strong returns averaging 16.2% per year in the past 10 years. 10 years look like a long track record, enough to entice investing in the S&P 500 today, based on this data. Let’s evaluate this theory:

1. Actual book-value growth calculated at a mere 6%: What was the growth in the book value of the S&P 500 companies in the past 10 years? We can calculate it as the difference between compounding the 16.2% price increase per year and about 9.6% price/book increase per year (x2.5 going from under 2 to nearly 5), which is 6% per year. It turns out that the past 10 years were not very exciting for the S&P 500 companies.

2. Valuations declined 9.6% per year: From the most recent cycle when valuations reached today’s valuations (year 2000), they declined from about 5 to about 2 in 10 years, which is equal to -9.6% per year.

3. If the past repeats itself, we can get -3.3% annual decline for 10 years = -28% total: If the companies do as well as the past 10 years = 6% per year, and valuations revert to normal as happened last time we reached today’s valuations = -9.6% per year, we get an annual decline of -3.3% per year, and a total decline of -28%.

We don’t know what the future will actually be. But, if you are projecting the past to the future, you should prepare for material declines for the S&P 500 over the next 10 years.

Quiz Answer:

Question 1: In the past 10 years, how much did the S&P 500 companies grow their book values (change in price divided by change in price/book)?

  1. 16.2%
  2. 6% [Correct Answer]
  3. -6%

Question 2: Last time the S&P 500 had approximately today’s valuations, what was its average annual performance in the following 10 years?

  1. 16.2%
  2. 10%
  3. -1% [Correct Answer]

See article for more explanations.

Disclosures Including Backtested Performance Data

2 Reasons I don’t Invest in Bitcoin

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Quiz!

What are good reasons to invest in Bitcoin? (There may be multiple answers.)

  1. It is a high-growth investment with low correlation to other investments.
  2. High growth as its adoption grows.
  3. Low transaction costs.
  4. Fast transfers.
  5. Free from government control.

2 Reasons I don’t Invest in Bitcoin

Bitcoin is a digital currency / cryptocurrency with many benefits over traditional currencies. This article doesn’t discuss these great benefits, but instead brings up reasons to not hold bitcoin and many other digital currencies for investment.

  1. Just like any other currency, Bitcoin doesn’t generate any value. There are plenty of investments that do generate value, including stocks (companies) and real estate.
  2. While Bitcoin has benefits over traditional currencies, many countries are working on digital currencies with values tied to their traditional currencies. These currencies will have the benefits of digital currencies with an additional big benefit over Bitcoin: central banks can control the supply of currencies, helping stabilize economies, and preventing recessions such as 2008 from turning into devastating depressions. This could stop Bitcoin from reaching the wide adoption that some people anticipate.

Bitcoin played a big role in learning about digital currencies, and designing digital currencies with values tied to traditional currencies. Yet, as an investment, there is nothing that gives me confidence that it won’t permanently decline by 50%, 90% or 99%, as government backed digital currencies come out.

Quiz Answer:

What are good reasons to invest in Bitcoin? (There may be multiple answers.)

  1. It is a high-growth investment with low correlation to other investments.
  2. High growth as its adoption grows.
  3. Low transaction costs.
  4. Fast transfers.
  5. Free from government control.

None of the answers is correct. Specifically:

  1. Bitcoin has historically been a high-growth investment with low correlation to other investments, but there are good reasons to expect the growth to be reversed into sharp declines, once digital currencies that are tied to traditional currencies come out. Read this month’s article to learn more.
  2. You can expect adoption to dramatically shrink once there are government issued digital currencies, that have additional benefits.
  3. Low transaction costs are a benefit of Bitcoin over traditional currencies, but not over traditional digital currencies.
  4. Same as #3.
  5. Bitcoin is currently free from government control, providing a benefit for certain uses including some illegal activities, but that is not a reason to hold them as an investment.
Disclosures Including Backtested Performance Data

Sales up 27%, Profits up 47%, Stock Down 7%! What Gives?

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Quiz!

Which of the following is the most promising investment?

  1. A company that is losing money and is priced low reflecting the losses.
  2. A profitable company that is underappreciated and priced low.
  3. A company with phenomenal profitability, that you shop from every day, and can’t live without.

Sales up 27%, Profits up 47%, Stock Down 7%! What Gives?

On 7/29/2021, Amazon reported spectacular Q2 sales growth of 27%. Profits grew even faster, at 47%. Yet, the stock declined 7% after the announcement. This is could be unsettling for investors that chose Amazon, given it’s amazing profitability.

What happened? These growth rates were below prior growth rates and the expectations. Stock prices move in response to changes in the company’s performance – a relative measure, as opposed to the absolute company performance. Once the bar is set very high, gains could be tough to achieve, and declines can be very rapid.

Did we get any warning signs? Yes, glaring ones. It’s P/E (stock price relative to earnings) was 69, and it’s P/B (stock price relative to company value or liquidation value) was 17. These numbers are huge, and reflect a company that is 100%’s better than other companies.

An extra difficulty: Stocks of successful companies sometimes go up far above their intrinsic value. It is partly the result of people choosing a company based on its success or even solely based on recent stock growth, while ignoring the stock price. You can do the same, and do well for some time, as people do in various pyramid schemes, or you can join at the peak and experience steep declines. The peak may come during a phenomenal quarter for the company.

How can you use this information? Whenever analyzing whether to buy a stock, look for companies that are underpriced relative to their performance. These include phenomenal companies that are underappreciated, as well as mediocre companies that are priced too low. If you find a company that you love and believe in, analyze how much of its value is already reflected in the stock price, before investing.

What is the future of Amazon’s stock? This question is outside the scope of this article. There are many positive and negative factors, and it’s not a trivial task to combine them to reach an answer. Here is a sliver of the factors: Will the company manage to revert back to its phenomenal growth of prior quarters, or even beat it? Will enough investors continue to bid up the price because they love the company, or because the stock price went up in recent years? Will competition eat into Amazon’s market share, or will Amazon gain even greater market share? Will interest rates in the US go up, hurting Amazon’s borrowing costs? The full list is very long.

Quiz Answer:

Which of the following is the most promising investment?

  1. A company that is losing money and is priced low reflecting the losses.
  2. A profitable company that is underappreciated and priced low. [Correct Answer]
  3. A company with phenomenal profitability, that you shop from every day, and can’t live without.

Explanations:

  1. If the company is priced appropriately, the next step is to check the odds of a turnaround towards profitability. Trusting a turnaround can be risky, and should be done with caution, based on strong evidence.
  2. The combination of profitability & underpricing is the ideal one. Underpriced profitable companies have the potential for extra returns compared to the average company.
  3. A phenomenally profitable company is a great start. If you can’t live without it, and others feel the same, it’s another positive sign. The missing part is whether the stock price reflects more or less of all these positives.

See article for more explanations.

Disclosures Including Backtested Performance Data

Tipping Point for Value?

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Quiz!

Which factors may contribute to value (low Price/Book) outperformance moving forward? (There may be multiple answers.)

  1. A change in sentiment.
  2. Rising bond interest rates.
  3. Expectation for inflation.
  4. Very low valuations.
  5. Very low valuations relative to growth (high Price/Book) stocks.
  6. Economic recovery from the pandemic.
  7. The best option out there.

Tipping Point for Value?

Last year will go into the history books given the pandemic. But another, less noticed, rare thing happened. Growth stocks, those with a high price relative to the company’s book value (P/B), or intrinsic value, went from very expensive to extremely expensive – a level barely second to the late 1990’s. While they’ve become more expensive for a while, there was a big spike in unprofitable small growth stocks. Last time we had a spike even close to this magnitude was around 1999. This is very reassuring for Value stocks, because often a long-lasting trend ends in a big spike in the direction of the trend, followed by a sharp reversal. For value stocks in the US, last time the reversal meant a 50% outperformance in a mere 2 years.

There are a number of logical reasons to see a reversal at this point:

  1. A change in sentiment: The reversal already started a few months ago, long enough for people to take note, and start treating it more like a new trend than noise.
  2. Expectation for inflation: Two forces are leading to an expectation for higher inflation: (1) Dramatic government stimulus; (2) The Fed planning to hold interest rates low until after inflation overshoots the typical target. Bond prices already started declining reflecting this expectation.
  3. Very low valuations relative to growth (high Price/Book) stocks: With the valuations of growth stocks going so much higher relative to value stocks, growth stocks became much more dangerous. People took note and started shifting towards value stocks.
  4. Economic recovery from the pandemic: Value stocks tend to outperform at times of economic recovery.

Note that value stocks outside the US have much lower valuations than US stocks – near record difference, making them even more appealing. As always, there could be surprises, and it is important to structure your financial picture to account for them.

Quiz Answer:

Which factors may contribute to value (low Price/Book) outperformance moving forward? (There may be multiple answers.)

  1. A change in sentiment. [Correct Answer]
  2. Rising bond interest rates. [Correct Answer]
  3. Expectation for inflation. [Correct Answer]
  4. Very low valuations.
  5. Very low valuations relative to growth (high Price/Book) stocks. [Correct Answer]
  6. Economic recovery from the pandemic. [Correct Answer]
  7. The best option out there. [Correct Answer]

Explanations: #4 is only partly correct. In the US value stocks are not low relative to their historic average, though they are very low relative to growth stocks. Outside the US, valuations are clearly low.

See article for more explanations about the correct answers.

Disclosures Including Backtested Performance Data

The Surprises & The Expected of 2020

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Quiz!

In which ways was 2020 different than other big declines (e.g. 2008 & 2000)? (There may be multiple correct answers.)

  1. It was deeper.
  2. It was shorter.
  3. It was scarier.
  4. It was longer.
  5. The turnaround came before economic improvement.
  6. The government & central bank support were bigger than usual.

The Surprises & The Expected of 2020

The pandemic of 2020 was shocking to investors and humans in general. It involved substantial uncertainty, leading people to predict years of pain for stock investments. While the split between surprises & the expected will vary depending on the reader, below is my split.

Surprises:

  1. While the key actions to contain the pandemic were known early on (looking at some Asian countries), the magnitude of unwillingness to take these actions seriously in other countries was greater than I expected, leading to a much worse result than possible otherwise. While stocks recovered rapidly, they could have bottomed higher, with fewer lives lost on the way.

Expected:

  1. The decline was shorter than typical, because it didn’t come from a position of economic leverage and euphoria.
  2. When panic took hold in March, the Fed repeated its 2008 announcement, being prepared to do whatever it would take to support the economy. Other countries operated similarly.
  3. The turnaround came as soon as the level of uncertainty diminished, far before the economy improved, as typical.
  4. While the economy is still hurting badly, it started the turnaround much earlier than in prior declines, thanks to the cause being a shock and not leverage.
  5. Many people said about this decline that it’s different, and will last much longer than past declines. Fortunately, this prediction failed, as typical when made at past times of uncertainty.

The specifics of every market decline are different, creating a need to prepare for declines of varying lengths & depths, worse than we experienced before. While the specifics vary, there are some truths that follow through the cycles, especially some level of correlation between starting valuations (e.g. Price/Book) of risky assets and the severity of the decline. With the right planning, whether cash set aside or low spending relative to liquid assets, there is no need to label any case as “this time is different”. The more prepared you are, the stronger you can be going through scary times, with discipline to avoid panic selling at the depth of the decline.

Quiz Answer:

In which ways was 2020 different than other big declines (e.g. 2008 & 2000)? (There may be multiple correct answers.)

  1. It was deeper.
  2. It was shorter. [Correct Answer]
  3. It was scarier. [Correct Answer]
  4. It was longer.
  5. The turnaround came before economic improvement.
  6. The government & central bank support were bigger than usual. [Correct Answer]

Explanations:

  1. This decline was shallower than the other two declines.
  2. This decline was dramatically shorter than the other two declines.
  3. While every decline is scary, this was scarier, because we haven’t seen such a widespread pandemic in our lifetimes.
  4. This decline was dramatically shorter than the other two declines.
  5. In most declines, the turnaround comes far ahead of the economic turnaround. It comes from a combination of government & central banks (e.g. the Fed) support along with an expectation for a future turnaround.
  6. Both 2008 and 2020 saw very big government & central bank support, but this year’s support was even bigger.

See article for more explanations.

Disclosures Including Backtested Performance Data

Testing Emerging Markets Value Investments in a Simple Graph

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Quiz!

Which of the following are good ways to judge the future of portfolios of value stocks?

  1. Look at their 1 year performance. Strong performance is good news.
  2. Look at their 1 year performance. Strong performance is bad news.
  3. Look at their 10 year performance from all historic cases with valuations similar to today. Strong performance is good news.
  4. Look at their 10 year performance from all historic cases with valuations similar to today. Strong performance is bad news.
  5. Look at their 10 year performance. Strong performance is good news.
  6. Look at their 10 year performance. Strong performance is bad news.

Testing Emerging Markets Value Investments in a Simple Graph

Value stocks are priced low relative to their intrinsic value (low Price/Book, or P/B). Value investing makes logical sense: when buying cheap stocks, you can expect to enjoy higher returns. It is not only logical, but also supported by nearly 100 years of evidence. This is all nice, until you look at the past 10 years and see that value underperformed growth (high Price/Book) for the whole period. This raises the suspicion of a new normal. Maybe the entire group of companies with low prices has something wrong with them, and their value will go down over time, to justify the low price?

There is an easy test to differentiate between bad companies and cheap investments:

  1. Bad companies: The underperformance is explained by underperformance of their book values relative to the rest of the market. This is why Warren Buffett tracks the book values of his companies more than prices.
  2. Cheap investment: A lot of the underperformance of value stocks is explained by a change in their valuations (P/B) relative to the rest of the market.

As an example, here is a comparison of DFA funds, one representing overall Emerging Markets (EM), and the other representing EM Value. The graph divides the valuations (P/B) of EM by EM Value. A high value represents an increase in the price paid for all of EM relative to the price paid for EM Value stocks.

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For the year (2020), EM Value underperformed EM by about 11%, while the valuations difference increased by 15%. This means that the value companies, as measured by their book value, did 4% better than the overall market. This supports the thesis that these investments are simply cheaper, and you may reap the benefit as the valuations continue their cycle.

Quiz Answer:

Which of the following are good ways to judge the future of portfolios of value stocks?

  1. Look at their 1 year performance. Strong performance is good news.
  2. Look at their 1 year performance. Strong performance is bad news.
  3. Look at their 10 year performance from all historic cases with valuations similar to today. Strong performance is good news. [Correct Answer]
  4. Look at their 10 year performance from all historic cases with valuations similar to today. Strong performance is bad news.
  5. Look at their 10 year performance. Strong performance is good news.
  6. Look at their 10 year performance. Strong performance is bad news.

Explanations:

  1. You cannot conclude anything positive or negative from a 1 year period.
  2. See #1 above.
  3. The combination of averaging many 10-year stretches with a focus on pricing (valuations) similar to today, gives useful information.
  4. See #3 above.
  5. After a decade of unusually good returns, the risk of a weaker decade goes up, so it is not necessarily a good sign.
  6. After a decade of unusually good returns, the risk of a weaker decade goes up, but it is also not a guarantee for a bad next decade.
Disclosures Including Backtested Performance Data

A Hidden Measure of Investment Risk, Beyond Volatility

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Quiz!

Which is a riskier situation?

  1. 1M invested in a stable investment that grows by 5% per year and never declines.
  2. 3M invested in a highly volatile investment that grows by an average of 8% per year and suffers significant frequent declines of up to 60% from the peak.

A Hidden Measure of Investment Risk, Beyond Volatility

This article debunks a conventional wisdom that equates volatility with risk, and ignores all other factors. The following example demonstrates a problem with this narrow focus. Compare the following two situations:

  1. 1M invested in a stable investment that grows by 5% per year and never declines.
  2. 3M invested in a highly volatile investment that grows by an average of 8% per year and suffers significant frequent declines of up to 60% from the peak.

By focusing on volatility alone, you would conclude that the first investment is less risky. This conclusion is wrong. The lowest balance that the stable investment can reach is 1M, since it never declines. The lowest balance that the volatile investment can reach is 1.2M, since it starts with 3M and can go down by up to 60% of the peak. The first investment is riskier for two reasons: (1) it grows more slowly on average, and (2) it has a lower worst-case balance. Your risk of running out of money with this investment is greater.

Since the starting investment amounts are different in the two cases, how can this apply to the real world? An example could help:

  1. Say you have 1M invested in a stable investment.
  2. The investments grow to 1.1M through a combination of investment growth and new savings. This allows you to shift your investments towards higher expected growth along with higher volatility. Specifically, the investments can potentially decline by another 100k (10%) during declines, to get you to the prior risk during declines.
  3. You repeat the step above, leading to higher and higher expected growth, while keeping the risk level the same.
  4. Your investments reach 2.5M, and you reached an allocation for maximum potential growth, along with potential declines of up to 60%. Your risk level is still the same with the lowest balance being: 2.5M x (1 – 60%) = 1M.
  5. Your investments reach 3M, and you keep the allocation the same, since you already enjoy the maximum potential growth. But now the lowest your investments can reach is up to 3M x (1 – 60%) = 1.2M, giving you higher security, despite the much higher volatility.

Notes:

  1. Risk is determined by spending/investments, not investments alone. To account for expenses going up or down, you should track spending/investments, not just the investment balance.
  2. Another risk factor is the valuations (P/B = Price/Book, or price relative to intrinsic value or liquidation value). In diversified portfolios, high valuations lead to higher risk (greater potential decline), and lower valuations lead to lower risk (lower potential decline).
  3. Some stable investments are exposed to inflation risk, making them riskier than seems.  On the other hand, there is no guaranteed maximum decline for any investment.  It is all a matter of odds.
  4. If higher volatility leads you to panic and sell low, that is another risk factor that can take away the financial benefits described above.
  5. While income from work can be lost at any point, some jobs are much more secure than typical (e.g. doctors), and can help your risk profile.

Implications:

  1. A plan that may be risky for someone else, may be conservative for you (and vice-versa), depending on your respective ratios of expenses/investments & valuations.
  2. A plan that would have been risky for you a few years ago, may be conservative for you today (and the reverse is potentially true if your expenses grow faster than your investments).

Quiz Answer:

Which is a riskier situation?

  1. 1M invested in a stable investment that grows by 5% per year and never declines. [Correct Answer]
  2. 3M invested in a highly volatile investment that grows by an average of 8% per year and suffers significant frequent declines of up to 60% from the peak.

Explanation: See article for explanations.

Disclosures Including Backtested Performance Data

Long-Term Protectionism is Unnatural and Not Likely

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Quiz!

Which of the following are expected results of protectionism (e.g. taxes on imports, quotas to limit imports)?

  1. Saving jobs.
  2. Lowering costs of products.
  3. Better products.

Long-Term Protectionism is Unnatural and Not Likely

Protectionism (e.g. tariffs = taxes on imports, quotas to limit imports) is done for two reasons:

  1. Temporary: negotiations between countries on different topics, alternatives to wars.
  2. Long-term: protect local producers from competition from foreign producers.

There is a concern about long-term protectionism (#2 above), that can affect stock prices. Long-term protectionism is unlikely for the following reasons:

  1. Unintended consequences: While higher prices save jobs in one industry, it costs jobs in other industries. It does so in two ways:
    1. Consumers have to pay a higher price for products, leaving them with less money to spend on products and services of other industries.
    2. When the consumer is a company, it has to raise its own prices to make up for the higher input cost. This makes the company less competitive with foreign producers that have lower input costs.
  2. Net loss: The higher cost to the consumers goes to benefactors beyond retaining jobs in the protected industry, including company profits (investors), manager bonuses, and higher pay to employees. For example, it cost consumers $826,000 per year for every saved job in the sugar industry in 2002 (Federal Reserve Bank of Dallas).
  3. Online Shopping promotes globalization: The coronavirus accelerated the transition to online shopping, where comparing prices is much easier than going to multiple physical stores. This gives a boost to cheaper products that are imported from countries with cheaper labor.
  4. Improved Quality: There was a time where buying from China involved a tradeoff – lower quality for lower price. The quality of products improved significantly and is no longer a concern, improving their exports.
  5. Economies of scale: Protectionism limits trade and reduces the number of buyers from each company. This hurts the scale of companies, leading to lower efficiencies.
  6. Specialization: Protectionism limits the market for each company, and reduces the opportunities to specialize.

Quiz Answer:

Which of the following are expected results of protectionism (e.g. taxes on imports, quotas to limit imports)?

  1. Saving jobs.
  2. Lowering costs of products.
  3. Better products.

None of the answers is correct. Specifically:

  1. Protectionism saves jobs in the protected industry, but takes away jobs from other industries. The overall effect is lost jobs.
  2. Protectionism artificially inflates the prices of the product coming from abroad, leading to a higher price.
  3. Protectionism limits the market of companies, leading to lower specialization and lesser economies of scale. At best, the quality of products stays the same, and at worst it is hurt.
Disclosures Including Backtested Performance Data

2 Hidden Risks of Selling Stocks Temporarily Now

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Quiz!

During a big decline, is selling stocks until the storm passes conservative?

  1. Yes.
  2. It is conservative at the moment, and likely riskier beyond that.
  3. No, it is risky to sell low.

2 Hidden Risks of Selling Stocks Temporarily Now

It may seem appealing to sell stocks now, and buy lower, when seeing signs of the end of the coronavirus damage. There are two hidden risks in such a strategy:

  1. Hidden Risk #1: A decline never comes, so you buy 10%+ higher. After the gain, the portfolio turns much lower. Now your investments bottom at an even lower point than without the temporary selling.
  2. Hidden Risk #2: Fast forward to the next peak. Another big decline follows. During the entire decline – from peak to bottom – you have less money.

A variation is to sell stocks now, and wait to buy until we are completely done with the coronavirus impact. This is likely to eliminate Hidden Risk #1, but it makes Hidden Risk #2 far worse. By the time we are completely done with the coronavirus impact, your investments could potentially be 100%+ higher. The impact on all future declines can be devastating.

You may be desperate for some relief from the stress of staying invested at a low point, and are still tempted to sell. The relief is an illusion:

  1. If you are stressed now, imagine the stress after selling, reinvesting higher and then going to the bottom with less money.
  2. You may be tempted to sell and not buy until far into the future. As strong as it is at relieving the current stress, it is devastating at the depths of the next decline – lowering its bottom dramatically.

By holding onto your investments, you ultimately get the portfolio returns. While stocks may face long periods with poor returns, it is much better than risking making future declines deeper and longer.

Mirroring the risks above, if you still have income and are able to invest at today’s low levels, you can boost your financial security in future declines for the rest of your life.

Quiz Answer:

During a big decline, is selling stocks until the storm passes conservative?

  1. Yes.
  2. It is conservative at the moment, and likely riskier beyond that. [Correct Answer]
  3. No, it is risky to sell low.

Explanation: See this month’s article.

Disclosures Including Backtested Performance Data