I agree, the worst thing to do is to sell your portfolio in the middle of a panic (recession, pandemic...). I have invested around half of my money in stocks and I never sell unless I need the money. I never look at stock markets live news.
I know people who say "I can't invest in the stock market, because I don't have time to often look at stock market news to buy and sell at the right time". How ironic it is that this is in fact precisely what NOT to do.
Buy and hold is the key to financial success! It's also, as you have noted, a great peace of mind. The only reason for an index investor to sell is to re-balance the portfolio once a year to respect the asset allocation.
A lot of values added by this article, thank you, some notes of reflexions :
- Indeed I think that gold is a better hedge than bonds, given the current QE policies of the FED.
- What seems to me the most balanced, if we take into account the investment theories of Nassim Nicolas Taleb (85% safe investment / 15% ultra risky with an asymmetry on ROI) the following investment structure seems to me the best :
- 85% divided into 80% S&P500 / 20% Gold
- 15% divided into 50% Tech Startups / 50% Bitcoin
In this way we can bet on several narratives:
- Humanity will continue to create value in the long term (S&P500)
- Gold is the hedging asset par excellence that has proven itself over thousands of years (Gold).
- The paradigm shift due to technology will bring exponential value creation in this sector. ( (Tech Startups)
- Bitcoin is a new form of store of value that may bring one of the largest transfers of value in history over the next few years and it is surely the most radical hedge to the current system. (Bitcoin)
Thanks! In my distant souvenir, the Taleb's barbell strategy was ~80% in bonds and gold and ~20% in speculative assets such as startups and crypto. He doesn't want to be exposed to the SP500. Anyway, the idea is to have concentrated risky investments and the majority of your wealth in "not-risky" (?) investment.
I have a gold position. Gold is a stupid investment because it produces nothing. At least, it doesn't lose purchasing power over time! Can't wait to sell my gold to buy SP500 with a decent P/E ratio. Thank you so much for the resource on gold. Truth is, I have gold because it has been around for ages but I don't understand well the gold market. I should read more about it!
Regarding startups, I don't have access to early rounds of Silicon Valley startups so I will stick with BTC :)
It's true I think I have a negative bias on bonds that made it shifted to the SP500 in my mind :). But yes, the idea is to have a large part of the stack in something ultra conservative and to have risky bets on a smaller one. :)
For gold it's a pretty fascinating asset to study in its financial function but also in history. It allows to see Bitcoin from a different prism.
Diego Parrilla is one of the great specialists in gold investment and his books are a real source of value. I've been studying this for some time and this talk between Raoul Pal and Diego Parrilla is a good introduction: https://www.youtube.com/watch?v=z83Rd160YGs&ab_channel=RealVisionFinance
Great article! I encourage you to read "A random walk down Wall Street" a great book on the same subject ;)
Regarding the bonds allocation in a portfolio don't you think that given (i) the low interest rates and (ii) the relatively high risk of inflation in the coming months/years due to all the cash put in the system by the central bank to outweigh the impact of the pandemic there is a significant probability that bonds will underperform?
Regarding real estate, historically it has been an asset weakly correlated with other assets therefore it might be a great pick to reduce the overall risk of a portfolio.
Thank you for your comment and for the book recommendation. Regarding real estate, it's an asset class that performed very poorly. Between 1948 and 2004 the real increase in value in the U.S real estate market was only 48%, an increase of less than 1% a year. That's really bad. The evidence shows low average rates of real appreciation of most homes and that consumer prices rise at the same path as home prices. It offers no capital gains for long term investors. Only recently home prices have started to rise fast leading to the housing bubble of 2008. Despite the crash, the low interest rates are fueling another bubble and Robert Schiller is once again warning of a real estate bubble.
I think people make the mistake to think that their house is their biggest asset. It's probably their biggest liability. Having a 20+ years mortgage for a big house in one location that is representing 90% of people's net worth isn't prudent at all. I like Warren Buffet's advice: " I decided to buy a house when it was about -- when the down payment was about 10% or so of my net worth, because I really felt I wanted to use the capital for other purposes." Having said that, for people who are afraid of investing in stocks, it can be an option to buy the house because it's still better than cash today.
The idea to balance bonds and stocks was they were inversely correlated (when stocks underperform, bonds then to outperform, and vice versa) and that bonds were a "no risk asset".
Also, bonds now have negative yields (in nominal or real yield) and even big national governments (not yet the US) have default risk as proved by the European sovereign debt crisis, when Greece, Portugal, Ireland, Spain and Cyprus were unable to repay their debt without the assistance of the European Central Bank (ECB) and the International Monetary Fund (IMF).
(Benjamin Graham's bible, The Intelligent Investor, was first published in 1949, so after a period of high debt + low yield, similar to ours, so maybe I'm wrong and his reasoning still applies today. But anyway investing in stocks = a bet that companies will continue to create value vs investing in government bonds = a bet that governments will continue to extract value?)
Question: is the "invest your age in bond" principle a thing of the past?
The Intelligent Investor was first published in 1949 and then updated until 1973. Key concepts didn't change although Graham adapted some valuation formulas. The current edition was updated by Jason Zweig who, while keeping the original text, provided useful comments to incorporate the realities of today’s market. His commentaries recall several moments where investors thought that "this time is different" and ended up losing their money. That's why I'm always skeptical when I read that "it's today different" ; but who knows?
I don't know if the correlation between bonds and stocks will change over the long term. The only thing I'm sure is that government always prints and the more debt the more money printing. The combination of inflation with low yield is terrible. The average annual inflation from 1990 through the end of 2018 was 2.46% per year and so a total cumulative inflation of 102.46%. Today's best money market account has a ~0.5% APY. If bonds keep providing a low yield and if inflation stays at an average of 2.46%, it means that a cash / short term bond position will depreciate at a rate of 2% per year.
I think because of that investors will seek yield at all cost buying junk bonds, growth stocks, expensive real estate etc. Assets are expensive today. For instance, using Buffet's formula about the expensiveness of the stock market (market cap / GDP), the stock market is significantly overvalued (179.9%). Same story when you look at the Schiller PE Ratio who stands at 33.24 versus a century median of 15.81. Companies will probably keep creating value but the price for this value might be different over time. So a 100% allocation in stocks seems a bit risky. Same for real estate I think. People will probably leverage massive loan with a negative real interest rate to buy very expensive home in order to protect themselves from inflation. I think it's a misallocation of resource because first real estate provides bad return, and then you have 90%+ of your net worth in one asset in one location. No need to say that if you lose your job, if your government starts taxing a lot real estate, or if the price of the home collapses people will face financial troubles.
Anyway, sometimes I think that it is hard to escape a policy designs to make people poorer. Inflation combined with low FED rate is the worst form of taxation. Investors will all lose money for some time, the question is how much of one's net worth. As Warren Buffet said, in a low yield environment "reaching for yield is really stupid. But it is very human." Let's adapt our consumption to this low yield environment, continue to invest for the long run and hope for the best!
The correlation was negative from 1900 to 2000, with the exception of a few years around ~1930 and ~1950. The correlation has been rising since ~1990, became positive in ~2000 and is still rising! The introduction of the article sums up the problem really well.
Yes, many people say "this time is different", and they often fail.
And yet, yes, things change other time. Rather than trying to predict the future (it's impossible) we can look at the past: Was the 60-40 portfolio advocated by Graham and co successful in the 16th century in Amsterdam? In the 17th century in England? In 1917 in Russia?
I don't know the answer but I suspect it's "no". Good luck if you had invested in a balanced portfolio of Russian equities and bonds in 1917. Or of Dutch equities and bonds around 1775. And the Netherlands were the world's most powerful empire at that time and the financial center of the world was Amsterdam. It was the equivalent of investing in the SP500 and US 10Y Treasuries today.
So yes, Graham's recommended allocation isn't atemporal. It may not have worked before. It may not work in the future...
Yeah, I've sold all my bonds in the past few years and the last I had this year, and it isn't an appealing investment to me whatsoever. But I wonder if liquid USD cash is the new bond replacement in a portfolio? While I would guess we are in the middle of a fiat hyperinflation event, it can still be useful for the occasional "deflationary shock" (BTFD). As a market prices in the new reality/information, it's a very wild ride, ex: the monetization of Bitcoin. So I suppose at 0% yield, cash = bond.
I agree with Antoine that sometimes it really is different! Probabilistically not THIS time, but let's remember unbacked fiat is a new(ish) experiment as well.
Bond is today an asset class with a negative real yield. If you buy bonds or cash equivalent you know that you will lose money over the next few years. I can't stop being astonished by that. I still understand why investors have a cash / bond allocation in case of a severe market crash.
I'm bullish on gold as a better hedge than bonds. Gold was almost a non existing market until people were allowed to buy it again in the US. Since then it lost value until 2000 when money printing started. With the FED going full Zimbabwe, gold might be part of the solution to the bond dilemma!
I agree, the worst thing to do is to sell your portfolio in the middle of a panic (recession, pandemic...). I have invested around half of my money in stocks and I never sell unless I need the money. I never look at stock markets live news.
I know people who say "I can't invest in the stock market, because I don't have time to often look at stock market news to buy and sell at the right time". How ironic it is that this is in fact precisely what NOT to do.
Buy and hold is the key to financial success! It's also, as you have noted, a great peace of mind. The only reason for an index investor to sell is to re-balance the portfolio once a year to respect the asset allocation.
A lot of values added by this article, thank you, some notes of reflexions :
- Indeed I think that gold is a better hedge than bonds, given the current QE policies of the FED.
- What seems to me the most balanced, if we take into account the investment theories of Nassim Nicolas Taleb (85% safe investment / 15% ultra risky with an asymmetry on ROI) the following investment structure seems to me the best :
- 85% divided into 80% S&P500 / 20% Gold
- 15% divided into 50% Tech Startups / 50% Bitcoin
In this way we can bet on several narratives:
- Humanity will continue to create value in the long term (S&P500)
- Gold is the hedging asset par excellence that has proven itself over thousands of years (Gold).
- The paradigm shift due to technology will bring exponential value creation in this sector. ( (Tech Startups)
- Bitcoin is a new form of store of value that may bring one of the largest transfers of value in history over the next few years and it is surely the most radical hedge to the current system. (Bitcoin)
Also a really interesting resource on gold: https://www.amazon.fr/dp/1947441825/ref=cm_sw_r_tw_dp_LqX.Fb0J4YXCB?_encoding=UTF8&psc=1
Thanks! In my distant souvenir, the Taleb's barbell strategy was ~80% in bonds and gold and ~20% in speculative assets such as startups and crypto. He doesn't want to be exposed to the SP500. Anyway, the idea is to have concentrated risky investments and the majority of your wealth in "not-risky" (?) investment.
I have a gold position. Gold is a stupid investment because it produces nothing. At least, it doesn't lose purchasing power over time! Can't wait to sell my gold to buy SP500 with a decent P/E ratio. Thank you so much for the resource on gold. Truth is, I have gold because it has been around for ages but I don't understand well the gold market. I should read more about it!
Regarding startups, I don't have access to early rounds of Silicon Valley startups so I will stick with BTC :)
It's true I think I have a negative bias on bonds that made it shifted to the SP500 in my mind :). But yes, the idea is to have a large part of the stack in something ultra conservative and to have risky bets on a smaller one. :)
For gold it's a pretty fascinating asset to study in its financial function but also in history. It allows to see Bitcoin from a different prism.
Diego Parrilla is one of the great specialists in gold investment and his books are a real source of value. I've been studying this for some time and this talk between Raoul Pal and Diego Parrilla is a good introduction: https://www.youtube.com/watch?v=z83Rd160YGs&ab_channel=RealVisionFinance
Thanks! Added the video to my gold education to-do list!
Great article! I encourage you to read "A random walk down Wall Street" a great book on the same subject ;)
Regarding the bonds allocation in a portfolio don't you think that given (i) the low interest rates and (ii) the relatively high risk of inflation in the coming months/years due to all the cash put in the system by the central bank to outweigh the impact of the pandemic there is a significant probability that bonds will underperform?
Regarding real estate, historically it has been an asset weakly correlated with other assets therefore it might be a great pick to reduce the overall risk of a portfolio.
Thank you for your comment and for the book recommendation. Regarding real estate, it's an asset class that performed very poorly. Between 1948 and 2004 the real increase in value in the U.S real estate market was only 48%, an increase of less than 1% a year. That's really bad. The evidence shows low average rates of real appreciation of most homes and that consumer prices rise at the same path as home prices. It offers no capital gains for long term investors. Only recently home prices have started to rise fast leading to the housing bubble of 2008. Despite the crash, the low interest rates are fueling another bubble and Robert Schiller is once again warning of a real estate bubble.
I think people make the mistake to think that their house is their biggest asset. It's probably their biggest liability. Having a 20+ years mortgage for a big house in one location that is representing 90% of people's net worth isn't prudent at all. I like Warren Buffet's advice: " I decided to buy a house when it was about -- when the down payment was about 10% or so of my net worth, because I really felt I wanted to use the capital for other purposes." Having said that, for people who are afraid of investing in stocks, it can be an option to buy the house because it's still better than cash today.
Great article!
Regarding bonds you cite Graham's recommendation.
I wonder if this recommendation is still true.
The idea to balance bonds and stocks was they were inversely correlated (when stocks underperform, bonds then to outperform, and vice versa) and that bonds were a "no risk asset".
However, the inverted correlation between bonds and stocks may have changed ( https://qz.com/1755700/the-60-40-split-for-investing-is-an-endangered-species/ ).
Also, bonds now have negative yields (in nominal or real yield) and even big national governments (not yet the US) have default risk as proved by the European sovereign debt crisis, when Greece, Portugal, Ireland, Spain and Cyprus were unable to repay their debt without the assistance of the European Central Bank (ECB) and the International Monetary Fund (IMF).
(Benjamin Graham's bible, The Intelligent Investor, was first published in 1949, so after a period of high debt + low yield, similar to ours, so maybe I'm wrong and his reasoning still applies today. But anyway investing in stocks = a bet that companies will continue to create value vs investing in government bonds = a bet that governments will continue to extract value?)
Question: is the "invest your age in bond" principle a thing of the past?
The Intelligent Investor was first published in 1949 and then updated until 1973. Key concepts didn't change although Graham adapted some valuation formulas. The current edition was updated by Jason Zweig who, while keeping the original text, provided useful comments to incorporate the realities of today’s market. His commentaries recall several moments where investors thought that "this time is different" and ended up losing their money. That's why I'm always skeptical when I read that "it's today different" ; but who knows?
I don't know if the correlation between bonds and stocks will change over the long term. The only thing I'm sure is that government always prints and the more debt the more money printing. The combination of inflation with low yield is terrible. The average annual inflation from 1990 through the end of 2018 was 2.46% per year and so a total cumulative inflation of 102.46%. Today's best money market account has a ~0.5% APY. If bonds keep providing a low yield and if inflation stays at an average of 2.46%, it means that a cash / short term bond position will depreciate at a rate of 2% per year.
I think because of that investors will seek yield at all cost buying junk bonds, growth stocks, expensive real estate etc. Assets are expensive today. For instance, using Buffet's formula about the expensiveness of the stock market (market cap / GDP), the stock market is significantly overvalued (179.9%). Same story when you look at the Schiller PE Ratio who stands at 33.24 versus a century median of 15.81. Companies will probably keep creating value but the price for this value might be different over time. So a 100% allocation in stocks seems a bit risky. Same for real estate I think. People will probably leverage massive loan with a negative real interest rate to buy very expensive home in order to protect themselves from inflation. I think it's a misallocation of resource because first real estate provides bad return, and then you have 90%+ of your net worth in one asset in one location. No need to say that if you lose your job, if your government starts taxing a lot real estate, or if the price of the home collapses people will face financial troubles.
Anyway, sometimes I think that it is hard to escape a policy designs to make people poorer. Inflation combined with low FED rate is the worst form of taxation. Investors will all lose money for some time, the question is how much of one's net worth. As Warren Buffet said, in a low yield environment "reaching for yield is really stupid. But it is very human." Let's adapt our consumption to this low yield environment, continue to invest for the long run and hope for the best!
FYI on stocks and bonds correlation look at Graph 1: https://www.rba.gov.au/publications/bulletin/2014/sep/pdf/bu-0914-8.pdf
The correlation was negative from 1900 to 2000, with the exception of a few years around ~1930 and ~1950. The correlation has been rising since ~1990, became positive in ~2000 and is still rising! The introduction of the article sums up the problem really well.
For the opposite point of view, read this one: https://www.pimco.co.uk/en-gb/insights/viewpoints/does-the-stock-bond-correlation-really-matter/
----------
Yes, many people say "this time is different", and they often fail.
And yet, yes, things change other time. Rather than trying to predict the future (it's impossible) we can look at the past: Was the 60-40 portfolio advocated by Graham and co successful in the 16th century in Amsterdam? In the 17th century in England? In 1917 in Russia?
I don't know the answer but I suspect it's "no". Good luck if you had invested in a balanced portfolio of Russian equities and bonds in 1917. Or of Dutch equities and bonds around 1775. And the Netherlands were the world's most powerful empire at that time and the financial center of the world was Amsterdam. It was the equivalent of investing in the SP500 and US 10Y Treasuries today.
So yes, Graham's recommended allocation isn't atemporal. It may not have worked before. It may not work in the future...
Yeah, I've sold all my bonds in the past few years and the last I had this year, and it isn't an appealing investment to me whatsoever. But I wonder if liquid USD cash is the new bond replacement in a portfolio? While I would guess we are in the middle of a fiat hyperinflation event, it can still be useful for the occasional "deflationary shock" (BTFD). As a market prices in the new reality/information, it's a very wild ride, ex: the monetization of Bitcoin. So I suppose at 0% yield, cash = bond.
I agree with Antoine that sometimes it really is different! Probabilistically not THIS time, but let's remember unbacked fiat is a new(ish) experiment as well.
Bond is today an asset class with a negative real yield. If you buy bonds or cash equivalent you know that you will lose money over the next few years. I can't stop being astonished by that. I still understand why investors have a cash / bond allocation in case of a severe market crash.
I'm bullish on gold as a better hedge than bonds. Gold was almost a non existing market until people were allowed to buy it again in the US. Since then it lost value until 2000 when money printing started. With the FED going full Zimbabwe, gold might be part of the solution to the bond dilemma!