Successful investing forces one to recognize and accept numerous paradoxes. Here are a few that even the most experienced investor should keep in mind.
If things can’t get any worse, they can only get better.
The chart below shows that the best time to buy is when it feels like the worst. The average subsequent 12-month returns in the S&P 500 after the last nine troughs in consumer sentiment is over 24% (compared to a 3.5% return after the last nine peaks).
Source: J.P. Morgan – Guide To The Markets 3Q2023
If you’re offered an IPO, you don’t want it.
Groucho Marx famously said that he would never join any club that would have him as a member. That’s how investors should view any IPO that is solicited to them from anyone other than a friend or family member who also happens to be the CEO of the company going public.
Two reasons. First, IPOs tend to be marketed to large institutional investors. The only time individuals get invited to the party is when the professionals have already looked at the deal and didn’t like it. This alone should be enough of a red flag.
Second, IPO performance has been terrible (chart on the left), and the quality of IPOs over the past decade has declined significantly (chart on the right). For example, the tan line depicts the percentage of IPOs with negative earnings has risen dramatically since 2010.
Since 40%-60% of IPOs generate negative returns even in good times1, finding the few winners in a vast sea of losers is critical. But extreme volatility and uncertainty make winners rarely look like winners for several years. That’s why most investors lack the resolve to benefit from them.
If it’s all up, then it’s not diversified.
Nobel Prize winner Harry Markowitz famously said that diversification is the only free lunch in investing. The “quilt” chart below of asset class returns supports this maxim.
The white box represents a broadly diversified portfolio, and it’s consistently produced relatively attractive and stable returns for well over a decade. But diversification requires owning asset classes that lag at times. In fact, if everything is up, the risks that diversification aims to eliminate are roaming free and could percolate at any moment.
If you want a career that is concrete and defined, don’t become an investor.
The Nobel Prize-winning physicist Richard Feynman once said: "Imagine how much harder physics would be if electrons had feelings."
Electrons don’t get greedy, nor do they panic. They always flow in the right direction, and predicting their movements is possible and can be done with incredible accuracy with the right tools and training.
Investing couldn’t be more different. The randomness and inability to forecast accurately is a byproduct of the emotional currents that drive financial markets. The chart below shows that not even the professionals can do it.
Source: Bloomberg, Darwin Asset Management analysis
So, if you’re looking for precision and certainty, become an engineer or a dentist. But if you like to be intellectually challenged, being wrong more times than right, and dealing with lots of moving parts, then investing may be for you.
Everyone is a long-term investor until they experience short-term losses.
Ernst & Young recently published a survey that found nearly half of the millennial respondents turned to cash last year due to market volatility2. That means they likely missed out on the subsequent rally. By comparison, just 34% of Gen X and 24% of Baby Boomers sought safety in cash.
If anything, they should have been one of the generations to sit back and relax because they have so much time before they need to sell. Furthermore, the chart below shows that a holding period of two decades has historically been ideal for owning stocks.
But using charts like the one above to reason with someone experiencing the gut-wrenching feeling of watching a portfolio in freefall for the first time would have been like prescribing penicillin to treat a viral infection. They needed experience, and that’s not something that can be gained by reading finance books and studying history.
Safe assets can often pose the greatest risk to a financial plan.
Home improvement, unexpected medical bills, kids, vacations, pets, and education are just a few of the expenses most of us will encounter before we retire. Add in taxes and inflation, and the chart below explains why not investing is risky.
The value of cash has fallen dramatically since 1980, and this isn’t a new phenomenon either. Go back to 1900, and the trend remains intact3.
If everyone is thinking alike, then somebody isn't thinking.
This legendary quote from George Patton reigns supreme in today’s financial markets. The chart below shows that the best money managers in public markets (orange-shaded area) have only slightly outperformed the worst. Perhaps this is because too many smart people are chasing the same ideas.
Now, look at the blue-shaded region. These represent the roads less traveled – strategies and asset classes that have barriers to entry and where expertise is hard to come by. Here, the returns have been more attractive, and manager skill has paid better (the spreads between the best and worst managers are larger).
The bottom line is that if you want to outperform in today’s markets, stray from the herd or find an experienced manager who can do it for you.
This material has been prepared for informational purposes only and should not be construed as a solicitation to effect, or attempt to effect, either transactions in securities or the rendering of personalized investment advice. This material is not intended to provide, and should not be relied on for tax, legal, investment, accounting, or other financial advice. You should consult your own tax, legal, financial, and accounting advisors before engaging in any transaction. Asset allocation and diversification do not guarantee a profit or protect against a loss. All references to potential future developments or outcomes are strictly the views and opinions of Richard W. Paul & Associates and in no way promise, guarantee, or seek to predict with any certainty what may or may not occur in various economies and investment markets. Past performance is not necessarily indicative of future performance.