Sunshine, Fear and Investment ManiasSubmitted by Fountain Financial Associates | Financial Advisors on February 20th, 2018
Posted on February 20, 2018 by Chris Riley
A new year is upon us, but don’t let this headline frighten you. Rather now is a very good time to talk about successful investing and the corresponding behavior associated with it.
“The time to repair a roof is when the sun is shining” - John F. Kennedy
President Kennedy’s quote feels appropriate as we look back on what has been a very sunny year. Positive returns in nearly all risk assets accompanied by very low volatility have made for smooth sailing for investors. While we also know that the “rain” (volatility and more challenging markets) will return as it always does, we have a chance to make any necessary repairs, minor or major, while this sunshine lasts. Maybe your roof is in perfect condition or needs a few patches. Our advice is simply to take stock of where things stand today and take advantage of this opportunity to think strategically and take action. Do you feel confident and prepared? Make sure the answer to that question is a resounding “Yes”.
Despite what media and “experts” may attempt to convince us, we are seeing very few signs of speculative or manic behavior today. Granted there are almost always pockets of performance chasing or hot new trends at any given point in time, but more importantly for us as successful long- term investors are understanding why fear and speculative behavior seem to derail so many well laid-plans. In 1841, a Scottish journalist Charles MacKay published “Extraordinary Delusions and the Madness Of Crowds”, to document the tendencies of people to think and act in herds. These are extraordinarily illuminating and, unfortunately, entertaining tales of chicanery, greed, and naivete. It was specifically to recount some of the most dangerous and economically injurious instances over the previous 300 years such as the Dutch Tulip Bubble, South Seas Bubble and Mississippi currency debacle. We may think that the Great Crash of 1929, the financial crisis of 2008, junk bonds of the '80s, and overvalued high-tech stocks of the '90s are peculiarly 20th and 21st century aberrations, but as this book highlights, the madness and confusion of crowds persist over time. Why do financially sensible people jump lemming-like into harebrained speculative frenzies -- only to jump out of windows (and investments) when their fantasies dissolve? As famous economist John Kenneth Galbraith observed: "There's nothing unique about this. It is something which happens every 20 or 30 years because that is about the length of the financial memory. It's about the length of time that it requires for a new set of suckers if you will, a new set of people capable of wonderful self-delusion to come in and imagine that they have a new and wonderful fix on the future."
So why talk about all of this today if we aren’t experiencing many of the symptoms of speculative manias? Only because it has happened before across many investable assets, and it is often very difficult to see in advance what will constitute future manias. What we do know is that a well diversified and patient investor will make more good decisions than bad, and that means never owning enough of any one idea to make a killing in it nor owning enough of one idea to risk being killed by it.
The investable universe continues to grow and expand as it has for centuries, but there are some proven, foundational tenets that we rely on to guide us as we invest today and into the future. Purchasing stock offers investors a residual claim on future profits, while a bond offers a promised stream of future cash flows, including the repayment of principle when it matures. The current price reflects the return that investors demand today for their cash today for an uncertain but greater amount of expected cash in the future. Their role in an investment portfolio is to provide positive expected returns by allowing investors to share in future profits earned by corporations of all types globally. From the largest publicly traded corporations worldwide to the smallest venture endeavor, the objective for investors is the same, regardless of risk level.
Holding cash, on the other hand, does not provide an expected stream of future cash flow. One US dollar held today does not entitle you to more dollars in the future. The same logic applies to holding other ‘stores of value’ such as gold, foreign currencies or newer forms of digital currency. Unless we can predict when one form of currency will appreciate or depreciate relative to others, we should not expect a positive return from one versus another.
Although these facts may seem somewhat obvious, they are foundational to any grounded investment process. Take a few moments to think about what’s most important to you and what can be done today to prevent “emergencies” in the future. We are encouraging clients to engage and take action while the sun is out and move into this year empowered and confident.