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Are concerns about investing near market highs valid?

19th November, 2020

Published in the Sunday Times on 22nd November 2020

It’s one of the seven deadly sins. It is seen as wasteful and self-indulgent. And it comes with a very bad reputation. The sloth is an arboreal mammal noted for slowness of movement and for spending most of its life hanging upside down in the trees of tropical rainforests. It has an extremely low metabolism and its slow deliberate movements are an evolutionary adaptation to avoid detection by predators who hunt by sight.

It is the natural world’s undisputed champion of lethargy and should be the perfect mascot for investors. But for a hyperactive culture obsessed with the next five minutes, its relevance may seem tenuous.

Sloth

There aren’t many walks of life in which you can recommend laziness as a virtue. Investment markets generally speaking are one of those domains.

And it’s endorsed by arguably the highest investment authority there is; Warren Buffett describes his investment process as one of “benign neglect, bordering on sloth”.

It should be no surprise then that I have regularly preached its virtues as it relates to investing. But in championing inactivity, I think I may have done investors a disservice. Sloth is all well and good, but it pre-supposes that your starting point is the correct one.

Overly conservative starting point

I have attended several client meetings recently, where the starting point is from an exceptionally conservative base, despite a much greater capacity to bear risk and a time horizon to support it. Inactivity hasn’t served these clients well in terms of the opportunity foregone. Lauding the Buffett approach is well intentioned, but misguided, in my view. Many investors’ starting point, in terms of strategy, is very different to his.

To have any chance at solving a problem, it is essential to diagnose it first. To the extent that clients are more conservatively positioned than their time horizon or capacity to bear risk would justify, a significant factor is concerns about investing near or at market highs and the potential for losses that implies. This diagnosis is undoubtedly incomplete. But it is frequently positioned to me as a contributory factor in unwillingness to make decisions.

Concerns about stock markets at all-time highs

Concerns in relation to a stock market downturn are justifiably widespread. Afterall we are at all-time market highs. The same concerns were voiced in 2017 when the US stock market made a record number of new highs. To smug holders of US equities, that was about 40% ago (in USD terms)! A downturn is inevitable I have no idea when this decline will happen, why it will happen nor how long it will last. Unless you’re comfortable with this sort of uncertainty, then a conservative investment approach may be warranted.

Risks that are real in the short term are rarely relevant in the long term. Take capital losses – arguably the most relevant investment risk of them all. Losses in the short term are real. Losses in the long term are rare. But to the extent that short term outcomes dominate decision making, a conservative approach is all but guaranteed.

A cultural imperative to avoid being wrong in the near term, means we have an overt focus on short-term performance. This, however, is mostly incompatible with being right in the long term — which should be every investor’s goal.

The trite advice is to think long term. That is laudable advice, but it is appealing to intellect. Investing is not an intellectual challenge.  The enemy of successful investing is not recessions. It is not financial crises. It’s not even global pandemics. It is indecision in the face of uncertainty. Successful investing is more an emotional or behavioural challenge than it is an intellectual one. Which is why advice is critical. Very few people are comfortable being uncomfortable, unless it’s part of a broad financial plan about which they have sought external counsel.

Make sure your starting point is correct before observing sloth

Let’s say your adviser has completed a financial plan, as a result of which you’ve committed to investing for a long period of time. You’re nervous about the timing. By all means, phase money in over a 12 or 18-month period and pray to the financial market Gods that the market declines by 20% or 30% (or even more) during this period.

Phasing doesn’t protect from losses. In fact the data says you are better off not phasing (Source: Vanguard). But if it’s the difference between a decision made and decision avoided, then it has obvious value in protecting against regret.

Once invested, then you can mimic our arboreal friend, and revisit the matter as infrequently as your conscience will allow.

Patience and low levels of activity are widely agreed tenets of successful investing. They are necessary, but they are insufficient. I’d suggest you assess whether your starting point is the correct one before applying the ‘benign neglect’ principle.

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