The current investment landscape is not an easy one to navigate. Technology stocks are trading at record highs; value stocks have been underperforming for years, although they have recently shown signs of life; bond rates are close to zero; and holding cash is a money-loser once inflation is taken into account. So, what are financial advisors and investors to do?
While the current investment environment is very challenging, the biggest risk that most investors with a long-term horizon face is not losing money, but not having enough of it. That’s why there’s no alternative to staying invested in a well-diversified portfolio.
Although there’s no magic formula, there are some prudent steps that can be taken to get through these challenging times. Here are three simple and proven investment strategies to consider:
1. Avoid extremes
There’s a growing group of investors who think they should concentrate their portfolios on a few big technology stocks – especially because of their strong performance during the COVID-19 crisis. That’s because the dopamine hit investors get when they make a correct bet on the market direction is often very stimulating.
That effect becomes difficult for investors to control and, as long as it’s working, they’re encouraged to take on more and more extreme bets on the market’s direction. They will consider it a better strategy than diversification.
The problem with this approach is that no stock or sector outperforms the market all the time. One day, something else will replace the performance generated by the big technology stocks – and nobody knows what that will be.
That’s why good advisors preach diversification even if it makes many investors feel remorseful in the short term. These advisors will also remind investors that diversification means getting the good, missing out on the extraordinary, but preventing the tragic.
For investors who are adamant on making such bets, advisors can suggest that they set up a “fun portfolio” in which they can place a smaller amount of money in a self-directed account. That will allow them to attempt to time the market without putting all of their assets at risk.
It’s an easy way for investors to fulfill that urge while ensuring most of their assets remain in well-diversified portfolios.
2. Prevent the default to cash
Faced with one of the most challenging investment environments in decades, some investors will shy away from investing altogether and default to cash. Although a global pandemic and growing geopolitical tension are two very good reasons to stay on the sidelines right now, there’s a big risk in doing so.
Holding too much cash in a portfolio leads to a vicious cycle. When the market goes up, investors tell themselves they’ll wait for the next correction; then, when the market goes down, they’ll say that they’ll wait for it to drop further. As such, investors who succumbed to a “cash addiction” in 2000, 2008, or even this past March paid a heavy price. Of course, it’s easy to look back at these dates in hindsight and say that investing during these periods was a no-brainer, but that’s never the case.
Finally, the accompanying table shows the lousy returns cash has provided to investors during the past 10 years. It’s very difficult for investors to reach their life goals if they get a negative real rate of return 10 years in a row. That’s why advisors help fight the addiction to cash among some investors by focusing on their financial plans, making sure they stay invested, and by helping them manage the inevitable cycles of fear and greed.
3. Focus on preparation more than predictions
Predictions are about trying to forecast the future while preparation is about setting the right expectations for whatever may hold. Investing has a lot more to do with preparation as it’s very difficult to foresee what will happen in the future correctly.
Good advisors can help investors prepare by performing a “pre-mortem” of their investment portfolios to know what could go wrong and how they should react if those scenarios were to happen. For example, advisors can help investors prepare for a situation in which tech stocks could fall by 25 per cent in a short time – and whether they should buy more shares or liquidate their positions.
Preparing for these situations ahead of time allows investors to follow a process instead of their emotions when these events happen. That leads to better results in the long term.
Jonathan Durocher is president of National Bank Financial Wealth Management.