In investment circles it is often said that “You make your money when you buy.” The basic notion is that the investor buys the stock of a good company that is temporarily selling at a low price and holds onto it until it can be sold at a much higher price. So, to have a good chance to make a profit one needs low prices as a starting point.The problem is that seldom has there been such an absence of low prices. Not just in stocks but in bonds. Not just in the U.S. but overseas.
The major factors pushing investment prices skyward include:
- Vastly increased borrowing by Central Government Banks around the world, which have used that money to buy up bonds (pushing up prices and pushing down interest rates) and even stocks (see chart)
- Historically low interest rates have enabled corporations to borrow money cheaply and use it to buy back their own stock
- An explosion in margin debt (investors borrowing money against their investments to buy more investments)
- A large increase in index investing where new money coming in is invested in a basket of stocks regardless of the current price
- Individual investors taking money out of money market funds and certificates of deposit and investing more aggressively in stocks in hopes of getting the returns they need
Based on the Shiller PE Ratio, which measures how the current stock market value compares to other periods of time, we now have the 2nd most expensive market over the last 100 years. Previously, when the market has been this high, the potential for positive returns has been greatly diminished. It’s hard to make money when you can’t “Buy low.”
“When the market has been in the 20% most expensive range (we are in the top 5% now) the average future return has only been 4.74% over the next three years. In contrast, the average maximum loss in that same timeframe has been -20.75%. That’s a lot of risk for minimal gain.” – Erik Ristuben, Russell Investments
“When markets are priced for perfection as they currently are, it takes very little disappointment to lead to significant shifts in the price of assets.” – Matt Kadnar & James Montier, GMO
At Journey Tree we ask ourselves not just what can we do to make money for clients but how can we minimize the potential for significant losses to their portfolios? Working to guard against large declines in account values is one of the most valuable things we do. Here’s why.
Incurring large losses means it becomes much more difficult to meet investor goals. The larger the loss the more challenging is it is just to get back to where you started. For instance, if your account drops 20% your need to make a return of 25% just to get back to where you started. (For example a $100,000 account would drop 20% to $80,000. You would then need to get a 25% return on that $80,000 to just get back to $100,000.)
If your loss is 30% then you need to make a return of 43% just to get back to where you started. So you can see it gets harder and harder to get out of the hole you’re in when your losses are bigger. And it becomes even more problematic when you are withdrawing income from your account in a down market. Not only has your account declined, but you are taking out money when it is low.
While the media reports on yet another record high for the stock market, we are focusing on risk management to help you through the inevitable rough times and opportunities that lie ahead.